Taxing Questions

Is the credit card company Visa a financial service? In a landmark decision handed down over the summer, the Tax Court of Canada held that it is not.

Canadian Imperial Bank of Commerce v. Her Majesty the Queen, 2018 TCC 109, means at least one major bank will not be repaid $18 million in GST and HST the bank argues it wrongly paid Visa Canada on fees it paid the company in connection with the use of the popular credit card.

The ruling has the potential to impact every Canadian bank and credit union that issues a credit card under its name. It raises the question of how credit-card HST or GST is, or will be, passed along, whether through increased annual card fees, higher rates on unpaid credit card balances, or small fee increases for all customers being just a few possibilities.

“There are a number of avenues they can take,” says William Innes, a tax practitioner at Toronto-based Rueters LLP. “They’re obviously going to take the ones that give them the least bad press and make them whole.” 

The decision itself cuts to the heart of what constitutes a financial service. It’s critical because, under the Excise Tax Act, a financial service is exempt from paying GST and HST while a non-financial service — even if it involves providing services that are financial in nature — is not

The decision affects not just CIBC but potentially all financial services such as banks, insurance companies and asset managers. Many millions of dollars turn on which category a credit card company falls into, with the potential to add as much as an extra 13 per cent on what the financial institution pays its card company.

The highly technical ruling, written by Tax Court Chief Justice Eugene Rossiter, is under appeal. You can bet every Canadian bank or credit union that issues a credit card and the credit card companies themselves are following developments very closely. There are 58 Schedule One and Two banks in Canada, as well as scores of credit unions and cooperatives and many, if not most, offer credit cards under their name.

Al Meghji, a tax litigator at Osler, Hoskin & Harcourt LLP in Toronto, who argued the case for CIBC and will argue the appeal, declined to discuss the details, but said generally speaking, “the definition of financial services that the judge in this case considered is extremely important to the financial-services sector in general. It appears that the courts are still trying to determine a coherent and workable definition.”
He points out that Canada is not alone in wrestling with this question. “This issue of whether something is a financial service or not has plagued the VAT [value-added tax] jurisdictions around the world. They’ve had the same problems in the UK and the European community, where they have to figure out whether something is a financial service. It’s been a problem in every VAT or GST jurisdiction. The industry’s complicated and when you’re trying to box things in, sometimes the lines aren’t so clear.”

The same may be said of Canada’s Excise Tax Act, which is enormously complex and detailed, and even contradictory. In defining a financial service, it sets a list of specific inclusions, another list of specific exclusions, and then a so-called “saving provision” that can turn an excluded entity into an included financial service based on risk.

Sometimes a company, as was the case with Visa, can fall into both inclusionary and exclusionary categories, leaving the question of whether its customers have to pay sales tax very much up in the air and depending on whether it meets the saving provision.

In deciding whether Visa should be in or out, Chief Justice Rossiter cited extensively from Great-West Life Assurance Company v. The Queen, 2015 TCC 225, in which the Federal Court of Appeal wrestled with a similar question involving a company called Emergis. It, not unlike Visa, he noted, was an intermediary that adjudicated and processed a financial institution’s claims. The judge found “both highly analogous to one another in that they both provide services that facilitate payments between parties.”

In administering health benefits for the insurer, Emergis offered a bundle of services, from maintaining a network to allow for the electronic submission of drug claims to creating end-of-day log files for Great-West.

In his 138-paragraph CIBC ruling, Chief Justice Rossiter pointed out that Visa similarly supplies a bundle of services: processing transactions; providing payment-management systems; licensing the Visa brand; and managing and promoting the card to the public.

The Court of Appeal held in Great-West Life that the answer to untangling a bundle lies in listing the array of services being supplied, then figuring out which predominates.

Chief Justice Rossiter noted that in Great-West Life, the appeal court held that the services Emergis provided were administrative as the payment process “did not involve any independent decision making” and involved “principally providing an easier and more cost effective way” for Great-West Life to pay out its drug benefits.

In essence, he wrote, the appeal court found the decision whether to pay out came not from Emergis but from the financial institution itself. Emergis provided a computer system that allowed the decision regarding a drug benefit claim to be made in real time. 

Building on that, he wrote that Visa’s service bundle should be characterized as a payment platform and a system that facilitates payments on its platform.

“The value added service which Visa provides to CIBC is to relieve them of the need to keep track of and then individually pay merchants for the transactions paid for on credit by CIBC clients,” he wrote. “Instead, Visa gives CIBC the ability to offer its clients the option of paying for goods and services on credit, while only needing to make one lump sum payment to Visa at the end of every day to settle the transactions.” 

At its most basic level, he said, “the benefit that Visa offered CIBC was cost saving and logistical simplification,” which he held to be “quintessentially administrative in nature.”

CIBC had argued that Visa should be considered a financial institution under the so-called “person at risk” clause, the saving provision that allows companies otherwise excluded from being treated as financial institutions to be included based on financial risk.

CIBC says Visa meets that definition because of the indemnification it provides to participants in its payment network, the corresponding exposure to potential settlement losses, and its ongoing exposure to potential foreign exchange losses.

Chief Justice Rossiter disagreed, saying it does not appear as though Visa was actually financially at risk as a result of the services it provided, at least not to the extent necessary to satisfy the provision. 
He noted that “Visa Inc. itself seemed to value its own probability adjusted risk exposure as being extremely low, with its 2009 filing with the SEC valuing its potential exposure at less than $1 million dollars.”
He added that although Visa’s theoretical risk is high, “this extremely low valuation presumably takes into account the risk-management techniques which are employed” by the company.

He wrote that Visa’s risk exposure is based on events “which have an extremely low probability of ever occurring,” and concluded that “the purely hypothetical remote risks that Visa Canada is subject to are insufficient for them to be considered a person at risk.” 

Nathalie Goyette, a Partner at PwC Law LLP in Montréal, says overall the ruling is a “serious, solid analysis” but added that the decision on the so-called saving provision “is quite novel. The question it raises is: how much at risk do you need to be to be considered ‘at risk’?

“The judge said there is some risk here, but not enough to be ‘at risk.’ So I imagine, but I don’t know, that part of the appeal will argue how much at risk you need to be at to be at risk, because the [bank] won on all other aspects. If you talk to other practitioners, they’ll tell you that’s the very novel, the very interesting aspect of this case.”

Innes of Rueters says, “if the decision has any Achilles heel, that’s probably it. The judge basically said the risk is illusionary. I don’t know what the evidence was but, if the Court of Appeal is going to attack anything, I think it would be that. When you’re involved in transactions as complex as Visa is and CIBC is, it’s often difficult to predict the limits of risk. To say that there is no effective risk assumed by Visa in this situation is a real leap of faith. You really have to have the evidence to bear that out, and possibly he does.”

At the end of the day, the ruling is important for consumers, says Cheryl Gibson, a tax partner and former head of the Edmonton Tax Group at Dentons Canada LLP

“Had CIBC been right, the consumer would have been better off. The one thing we know is any bank is ultimately going to transfer additional cost down to the consumer, one way or another.

“The government is going to be thrilled with this decision because this is a huge amount of money going into its coffers for GST [and HST]. The government would have been very unhappy to see this amount of money lost had it gone the other way, because these are very large dollars.”