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Focus: Federal Court decision has GST implications for late payment fees

26 June 2009

In brief: A recent decision of the Federal Court addresses the nature of supplies made in the provision of charge cards and credit cards. It is a significant early step in what is likely to be a sometimes tortuous journey – the judicial interpretation of Australia's financial supply rules. It may turn out to have implications well beyond credit cards. Partner Ross Stitt (view CV) reports.

• Introduction
• The dispute
• A provision of credit
• 'In connection with'
• Payment systems
• What's next?

Introduction

American Express International v Commissioner of Taxation ¹ reveals fundamental weaknesses in how the financial supply concept is defined; weaknesses that both the Commissioner and taxpayers often choose to overlook, in order to give effect to the perceived policy intent of the regime. Not for the first time, when a judge has been called on to interpret GST legislation without the baggage of preconceived notions as to how the GST regime is intended to operate, he has come up with an answer that is at odds with both perceived policy intent and market practice.

The dispute

The dispute between Amex and the Commissioner arose from the apportionment methodology Amex used to claim input tax credits for costs incurred in its charge card and credit card businesses. The issue was whether fees charged by Amex to cardholders for failing to pay amounts when they were due were consideration for input taxed financial supplies.

An Amex charge card can be used by the cardholder to pay for goods and services. No credit is available to the cardholder. The cardholder receives a monthly statement, and failure to pay the full amount outstanding by the due date results in the imposition of a fee. An Amex credit card can be used like a charge card to pay for goods and services, but offers the additional facility of credit. The cardholder receives a monthly statement and can elect to utilise the available credit to defer payment. However, a minimum monthly payment is always required; failure to make it results in the imposition of a fee.

In calculating its entitlement to input tax credits for costs incurred, Amex used a revenue-based apportionment methodology. It did not include the late payment fees as consideration for input taxed financial supplies. The Commissioner challenged Amex's apportionment, on the basis that the late payment fees were 'in connection with', and therefore consideration for, the supply by Amex of interests in 'a debt, credit arrangement or right to credit' – item 2 in the table in Regulation 40-5.09(3) of the GST Regulations. Amex argued that the fees were not consideration for such supplies but, rather, were penalties paid by cardholders as a consequence of breaching their obligations to make payments when due. According to Justice Emmett's judgment, Amex also argued that if the charge card and credit card facilities involved supplies, they were supplies of a 'payment system' and, therefore, were expressly excluded from input taxed financial supply classification by item 4 in Regulation 40-5.12.

A provision of credit

Much of the judgment is devoted to whether the delay between the time that a cardholder uses their card and the date for payment to Amex gives rise to a provision by Amex to the cardholder of an interest in, or under, a credit arrangement or a right to credit. Justice Emmett concluded that it does not. Nevertheless, he did seem to accept that a debt owed by the cardholder to the card issuer was created – that is, a financial supply – but he did not analyse its implications in any detail.

'In connection with'

Justice Emmett then turned to the meaning of the words 'in connection with' in the context of the consideration definition. He appeared to accept that the provision of a credit card facility comes within item 2 in Regulation 40-5.09(3) and, therefore, prima facie constitutes a financial supply. However, he found that a late payment fee is not made in connection with that particular supply. It is not paid in consideration for the provision of the interest in the credit arrangement or a right to credit. Furthermore, it is not paid in consideration for the debt created upon a charge being debited to a cardholder's account. Rather, he saw a late payment fee as 'liquidated damages'; a penalty imposed on a cardholder for breaching the terms and conditions of the facility.

Given this, Justice Emmett held that the late payment fees should not be taken into account as consideration for financial supplies in applying Amex's apportionment methodology for the calculation of its input tax credit entitlement, vis-a-vis acquisitions in relation to the provision of charge card and credit card facilities.

Justice Emmett's analysis raises as many questions as it answers. If a late payment fee is not consideration for a financial supply, is there a risk that it is consideration for a taxable supply? That would make Amex liable for GST on the fee, a worse result than a partial denial of input tax credits. In saying that a fee is a penalty imposed on a cardholder for a breach of contractual terms, Justice Emmett did not say that it is not consideration for a taxable supply. Unfortunately, he did not make any comment on the nature of damages and penalty payments for GST purposes. The High Court in Commissioner of Taxation v Reliance Carpet Co Pty Ltd ² accepted that a payment can both be in the nature of damages and be consideration for a taxable supply.

This element of Justice Emmett's judgment potentially has implications well beyond charge cards and credit cards. There are many other financial products and arrangements where fees are charged for late payment or contractual breach. Broadly speaking many of these fees would usually be treated as consideration for financial supplies. This decision casts doubt on that treatment.

The Commissioner is likely to accept only two treatments in relation to a fee earned by a GST registered entity in carrying on a domestic business – either that it is consideration for a taxable supply and, therefore, subject to GST; or that it is consideration for an input taxed supply and, therefore, factored into input tax credit entitlement calculations. In most circumstances, he can be expected to resist any suggestion that business fees can be attributable to out-of-scope supplies or not attributable to any supplies at all. Evidence of this can be seen in the approach adopted in the public ruling on cancellation fees.³

Payment systems

After dealing with the 'consideration' issue, Justice Emmett addressed Amex's alternative argument about payment systems. He decided that the 'three party card system' operated by Amex involves the supply of a payment system for the purposes of item 4 in the table in Regulation 40-5.12 and is thus specifically excluded from being a financial supply. On that basis, he concluded in paragraph 70 that 'there is no financial supply involved in the operation of the Charge Card Facility and Credit Card Facility by Amex'. On its face, this is a remarkable conclusion and one that seems difficult to sustain in the context of the GST Regulations. Surely the provision of credit on a credit card by the card issuer to the cardholder is not a supply of a payment system. It is hard to imagine that Justice Emmett intended his observation about the absence of any financial supply to apply to all aspects of the operation of charge card and credit card facilities.

If Justice Emmett did have that intention and he was correct, the only logical conclusion would be that the operation of charge card and credit card facilities must involve the making of taxable supplies. That would mean that card issuers would be liable for GST on consideration received for making those supplies. While late payment fees might not constitute consideration, there would be other consideration and it would attract GST. That would be a radical departure from the current treatment adopted by card issuers.

What's next?

As a minimum, the Amex decision will have credit card issuers reviewing the apportionment methodologies adopted in previous periods, and recalculating their input tax credit entitlements on the basis that late payment fees are not consideration for financial supplies. For that reason alone, it seems inevitable that the Commissioner will appeal the decision.

Published 26 June 2009

Footnotes

1. American Express International v Commissioner of Taxation [2009] FCA 683.
2. [2008] HCA 22.
3. GSTR 2009/3.

For further information, please contact:

• Ross StittPartner, Sydney
  Ph: +61 2 9230 4643
  Ross.Stitt@aar.com.au
• Peter AllenPartner, Brisbane
  Ph: +61 7 3334 3350
  Peter.Allen@aar.com.au
• Michael PerezPartner, Melbourne
  Ph: +61 3 9613 8500
  Michael.Perez@aar.com.au

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