Introduction
In the 2023 Budget, Parliament announced proposed amendments to the definition of “financial service” under the Excise Tax Act (“ETA”). The express intent of the legislature was to respond to the Federal Court of Appeal’s decision in Canadian Imperial Bank of Commerce v. Canada, 2021 FCA 10 (the “FCA Decision”), which found that the supplies CIBC received as a participant in the Visa payment system qualified as exempt financial services, giving rise to substantial rebates for tax paid in error in certain cases.
The new statutory provision at paragraph (r.6) of the definition of “financial service” in subsection 123(1) of the ETA (“paragraph (r.6)”) may apply to a service rendered under an agreement for a supply if any consideration for the supply becomes due after March 28, 2023. Remarkably, it also applies retroactively if all the consideration for the supply became due or was paid on or before March 28, 2023, in cases where tax has been collected or remitted in respect of the supply.
The purpose of this article is threefold. First, to summarize what compelled Parliament to make this amendment. Second, to describe the mechanics of paragraph (r.6) as an exclusionary provision. And finally, to discuss some practical implications for payment card network businesses and clients.
Please note that, at the time of drafting, the Financial Services and Financial Institutions (GST/HST) Regulations (“Regulations”) had not yet been amended in accordance with Parliament’s intention to provide for exceptions to paragraph (r.6). These exceptions are discussed in the companion article linked above.
Genesis of the Amendment — CIBC v. Canada
For years, it appeared that the supplies financial institutions acquired as participants in payment card network operators’ (“PCNO”) payment systems, such as Visa and Mastercard, had generally been understood, both by the industry and by tax authorities, as taxable administrative services.
In fact, CIBC had paid GST/HST on such services acquired from Visa for at least a decade, from 2003 to 2013. Then, CIBC decided to file applications for rebates under section 261 of the ETA for tax paid in error on the basis that these services qualified as exempt financial services.
The rebates were denied by the Canada Revenue Agency (“CRA”), and the dispute was litigated in the Tax Court of Canada in Canadian Imperial Bank of Commerce v. R., 2018 TCC 109 (the “TCC Decision”) and, together with the FCA Decision, (“CIBC v. Canada”). The TCC Decision found that the services provided by Visa (the “Visa supply”) were excluded from the definition of “financial service” as a prescribed administrative service under paragraph (t).
The Federal Court of Appeal reversed the TCC Decision. In the FCA Decision, the court found that the Visa supply ought to be considered a single compound supply, comprising several but indivisible components, that qualifies as a financial service under paragraphs (a), (i) and (l) of the definition of “financial service” under subsection 123(1) of the ETA.
Before diving into the minutiae of how the legislature responded to this decision, it is worth considering the context of a typical transaction using a credit card. As described in the FCA Decision, such a transaction involves at least five parties:
- the cardholder who uses a credit card to pay for goods or services;
- the merchant, which accepts the credit card as payment;
- the issuer — CIBC in the case at hand —, which issued the credit card to the cardholder and provides the cardholder with credit;
- the acquirer, which entered into an agreement with the merchant to accept or facilitate credit cards as payment; and
- the PCNO — Visa in the case at hand —, as operator of the payment system.
In effect, the FCA Decision determined that, in the context of a credit card payment transaction, supplies made by a PCNO to an issuer are financial services.
Amendment and Practical Implications
In response to the Federal Court of Appeal’s findings, Parliament added paragraph (r.6) as an exclusionary provision to the definition of “financial service”. It applies to a service — other than a prescribed service — supplied by a payment card network operator in respect of a payment card network where the service is:
- a service in respect of the authorization of a transaction in respect of money, an account, a credit card voucher, a charge card voucher or a financial instrument;
- a clearing or settlement service in respect of money, an account, a credit card voucher, a charge card voucher or a financial instrument; or
- a service provided in conjunction with a service referred to in subparagraph (i) or (ii).
In the preamble, the provision is written to restrict its application exclusively to supplies made by a PCNO. It then refers to a service that is “in respect of the authorization of a transaction” or that is “a clearing or settlement service” without mentioning the recipient.
This broad description of the excluded services appears to target, in effect, not only services rendered by a PCNO to an issuer of credit cards, such as in CIBC v. Canada, but also services rendered by a PCNO to an acquirer.
Indeed, the role of the PCNO in a given credit card transaction is to process the authorization of the transaction through electronic communications with both the acquirer bank and the issuer. A PCNO will then sort and provide clearing records to issuer banks as well as determine settlement amounts to be paid to acquirers.
The whole process is enabled by the PCNO’s governing rules, which are a body of contractually binding by-laws, operating regulations, guides and directives. For these services, a PCNO charges a fee to both issuers and acquirers who benefit from participation in the PCNO’s payment system.
Under paragraph (r.6), the fees paid for these supplies are excluded from the definition of exempt financial services. This should therefore clarify that there is an unrecoverable GST/HST — and QST in Quebec — cost to an acquirer or issuer paying for participation in a PCNO’s payment system, taking into account that the acquirer or issuer will be involved in exempt activities and use the taxable services supplied by the PCNO in the course of those exempt activities.
Additional Comments and Observations
As mentioned in the introduction, the new provision has retroactive effect. Although, at first glance, it may seem to have radical implications, the net result does not.
Paragraph (r.6) applies retroactively to cases where consideration for a supply became due or was paid on or before March 28, 2023, and for which tax had been collected or remitted.
The purpose is merely to prevent the filing of applications for rebates under section 261 of the ETA based on CIBC v. Canada for past transactions. It also implies that, in Parliament’s view, these services were taxable all along and that paragraph (r.6) is simply a clarification of that situation.
As noted above, some exceptions to paragraph (r.6) were expected to be added as “prescribed services” under the Regulations. According to the Department of Finance’s technical notes for the amendment introducing paragraph (r.6), the intent was to create an exception where a PCNO performs the services while also acting as an issuer or an acquirer. At the time of writing, it was unclear whether this exception would apply to a real-world situation given the structure of the industry.
Conclusion
Even if the amendment to the definition of “financial service” was in response to the FCA Decision, which specifically concerned supplies of services between a PCNO and an issuer, it seems that Parliament intended to capture services rendered by PCNOs to both acquirer banks and issuer banks.
In this context, the real impact of this amendment is to clarify that there is a GST/HST — and QST in Quebec — cost to financial institutions, which typically cannot recover tax paid on inputs, for participation in a PCNO’s payment system. It will be interesting to observe whether this cost will be passed on to merchants or absorbed by the financial institutions that incur it on a going-forward basis.