Introduction
On August 4, 2023, the Department of Finance Canada (“Finance”) published the Legislative and Regulatory Proposals Relating to the Excise Tax Act, the Excise Act, 2001 and the Select Luxury Items Tax Act, which included draft amendments to the Financial Services and Financial Institutions (GST/HST) Regulations (the “Draft Regulations”).
The proposed Draft Regulations address Parliament’s intention to provide for exceptions to new paragraph (r.6) of the definition of “financial service” in subsection 123(1) of the Excise Tax Act (“ETA”) (“paragraph (r.6)”). The exclusionary provision at paragraph (r.6) carves out an exception for “prescribed services”.
The purpose of this article is to examine the nature of these prescribed services in relation to paragraph (r.6) in light of Finance’s stated intentions and to discuss practical implications for payment card network businesses and clients.
Proposed Subsection 3.2(1)
The proposed addition to the Draft Regulations at section 3.2 is divided into subsection (1), which provides definitions applicable for purposes of section 3.2, and subsection (2), which describes what qualifies as a prescribed service and is therefore intended to remain an exempt financial service under paragraph (r.6).
Proposed subsection 3.2(1) is further divided into paragraphs (a) and (b).
Paragraph 3.2(1)(a) clarifies that the terms “acquirer”, “issuer”, “payment card”, “payment card network” and “payment card network operator” (“PCNO”) are deemed to have the same meanings as in section 3 of the Payment Card Networks Act.
Paragraph 3.2(1)(b) is particularly interesting in that its practical implications remain uncertain. Under this paragraph, a “payment service provider” (“PSP”) has the same meaning as in section 2 of the Retail Payment Activities Act. A PSP is defined under section 2 as a person that performs payment functions as a service or business activity that is not incidental to another service or activity.
Consequently, it appears that PSPs will be performing payment functions as a principal business, therefore excluding acquirers whose performance of payment functions would be considered incidental to the performance of financial services and not their principal business.
Further, pursuant to the Retail Payment Activities Act, a PSP “must be registered with the Bank of Canada before it performs any retail payment activities”. As of the date of publication, the Bank of Canada had not started its registration pilot for PSPs. In other words, no entity currently qualified as a PSP in Canada and the legislation, as drafted at that time, did not seem effective in this regard.
Proposed Subsection 3.2(2)
Pursuant to subsection 3.2(2) of the Draft Regulations, five sets of circumstances in paragraphs (a), (b) and (c) are identified as constituting the provision of a prescribed service for purposes of paragraph (r.6).
Prescribed Service #1
Paragraph 3.2(2)(a) describes a service supplied by a payment card network operator that enables a merchant to accept payments by payment card by providing the merchant, or a payment service provider engaged by the merchant, with access to a payment card network for the transmission or processing of the payments.
This first prescribed service involves a PSP or a merchant as the recipient and the PCNO as the supplier.
Prescribed Service #2
Paragraph 3.2(2)(b) describes a service rendered to a holder of a payment card and supplied by a payment card network operator in its capacity as the issuer of the payment card.
Prescribed Service #2 involves the holder of a payment card as the recipient and the PCNO as the supplier.
Three Other Prescribed Services
Subparagraphs 3.2(2)(c)(i), (ii) and (iii) designate three additional services in respect of the settlement of a transaction made by payment card:
- a service supplied by a payment card network operator, in its capacity as the acquirer for the transaction, to the issuer of the payment card;
- a service supplied by a payment card network operator, in its capacity as the issuer of the payment card, to the acquirer for the transaction; and
- a service supplied by a payment card network operator to the acquirer for the transaction if the consideration for the supply equals the fee payable by the payment card network operator to the issuer in respect of the settlement of the transaction.
These three prescribed services involve, on the one hand, a PCNO as the supplier of the service and, on the other, the acquirer or the issuer as the recipient.
Commentary
In its explanatory notes published in conjunction with the proposals, Finance elaborates further on the nature of the services targeted as prescribed services under the Draft Regulations.
In respect of Prescribed Services #1, #2, #3 and #4, Finance states in its explanatory notes that such services are supplied by a PCNO “in its capacity as an acquirer or as an issuer” rather than as a PCNO. Interestingly, it appears that, in the structure of the industry at the time, these scenarios were unlikely to arise.
In general, PCNOs are distinct from financial institutions that are in the business of issuing payment cards or maintaining merchants’ accounts and settling payment card transactions for merchants. In contrast, the business of a PCNO is to operate a network where information is exchanged between financial institutions for the facilitation and settlement of a payment card transaction. It is by nature an intermediary between these financial institutions that acts much like an arbiter in approving transactions and coordinating their settlement.
In short, paragraphs 3.2(2)(a) and (b) and subparagraphs (c)(i) and (ii) did not appear likely to have many implications in the context of the Canadian payment-clearing-services industry as it was then structured.
As for subparagraph (c)(iii), describing Prescribed Service #5, it is the only case where Finance did not intend it to be a supply by a PCNO in its capacity as an acquirer or an issuer. In fact, it was intended to clarify that the service supplied by a PCNO to the acquirer — paying the face value of a transaction on behalf of the issuer — remains an exempt financial service.
Conclusion
Paragraph (r.6) is, at its root, a rejection by Parliament of the Federal Court of Appeal’s decision in Canadian Imperial Bank of Commerce v. Canada, 2021 FCA 10. In that decision, the FCA found that access to a PCNO’s payment system or network, including all related benefits and services to participants, constituted an exempt financial service. This was widely understood to be contrary to Parliament’s long-held intention.
The remedy was paragraph (r.6), which deems services supplied by PCNOs in respect of a payment card network to be taxable. However, the policy underlying the exceptions established by the Draft Regulations remains unclear.
The stated purpose of Prescribed Services #1, #2, #3 and #4 is to have services provided by PCNOs in their capacity as acquirers or issuers remain exempt. The logical conclusion is that a true acquirer or issuer financial institution that developed a payment card network and became a PCNO in its own right would be excluded from making taxable supplies under paragraph (r.6). In other words, the Draft Regulations would prevent such a financial institution from recovering potentially important amounts of input tax credits in relation to these deemed taxable supplies.
Prescribed Service #5 is more straightforward. It simply excludes one of the services commonly performed by PCNOs from the application of paragraph (r.6): acting as a conduit for the actual settlement of a payment card transaction. Considering the prima facie nature of this service as a financial service distinct from access to a payment card network, this exclusion should not be controversial.