Tax Court of Canada Judgments

Date: 20010405

Docket: 1999-3262-GST-I; 1999-3263-GST-I

BETWEEN:

DRUG TRADING COMPANY LIMITED (FORMERLY NORTHWEST DRUG COMPANY LIMITED),

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Bowie, J.

[1]            The Appellant is a wholesaler of pharmaceutical, health care and related products. Its customers are independent retail pharmacies which operate under one of a number of well-known names such as "I.D.A.". It brings these two appeals from assessments for goods and services tax (GST) under the Excise Tax Act (the Act) which the Respondent asserts is payable in respect of what is described in the "summary of assessment" accompanying one Notice of Assessment as "GST collectible on Visa and MasterCard charges resupplied to customers", and on that accompanying the other Notice of Assessment as "GST collectible on the resupply of credit card charges to accounts receivable". There are two assessments covering overlapping periods of time, because the Appellant's business was carried out by two separate corporations before their amalgamation on March 1, 1999. One assessment covers the period from January 1, 1993 to December 31, 1996, and is for tax of $34,032.75; the other covers the period from January 1, 1992 to December 31, 1995, and is for tax of $120,427.35.[1] Penalties and interest have also been assessed. The appeals from both assessments were heard together on common evidence.

[2]            For convenience, I shall refer in these Reasons to the predecessor companies which carried on the business during the periods assessed collectively as the Appellant. I shall refer to the retail pharmacy chains as I.D.A., as that is the chain that was referred to in the evidence. The appeals were presented by the Appellant, and resisted by the Respondent, on the basis that the evidence as to the I.D.A. stores applied equally to the Appellant's other customers, and that the same agreement and procedures were in place between the Appellant and each of the two banks with which it dealt.

[3]            There are few primary facts in dispute. The Amended Reply to the Notice of Appeal in each case sets out exhaustively the Minister's assumptions of fact which I reproduce here in their entirety. The Appellant disputes only those which I have italicized.

12(b)        at all material times the Appellant was a registrant for the purposes of the Act;

(c)            the Appellant was required to file its returns on a monthly basis;

(d)            the Appellant filed returns reporting tax collectible, input tax credits and net tax as set out in Schedule A attached hereto;

(e)            at all material times the Appellant was a wholesaler/retailer engaged in the business of making supplies to drug stores, general stores, hospitals, clinics, veterinarians and farmers;

(f)             the Appellant administered certain programs, such as the I.D.A. program, which united specific customers under a "common banner of distribution and service";

(g)            certain customers of the Appellant, in particular drug stores, were allowed to join one of the programs the Appellant administered;

(h)            the customers referred to in the two preceding subparagraphs were independently owned stores;

(i)             to join a program administered by the Appellant the Member entered into a membership agreement with the Appellant;

(j)             the Member opened a trade credit account with the Appellant to facilitate the purchase of inventory from the Appellant;

(k)            under the terms of the membership agreement the Appellant supplied products for resale and services and products consumed by the Member in the course of the Member's business;

(l)             the supplies the Appellant made to the Member under the membership agreement included, among other things, a license to use the program's trademark and the right to receive the benefit of any volume discounts granted to the Appellant;

(m)           the membership agreement did not specifically refer to any arrangements the Appellant had made with the financial institutions;

(n)           the Members did not provide express or implied consent to the Appellant for the Appellant to act as their agent;

(o)            the Appellant entered into a MasterCard Major Merchant Agreement with the Bank of Montreal ("Master Card Agreement");

(p)            under the terms of the MasterCard Agreement the Appellant was assigned an account number;

(q)           the MasterCard Agreement established the terms of the relationship between the Bank of Montreal and the Appellant, including the Discount Fees and the deposit procedures;

(r)             the Appellant also entered into a major merchant agreement for Visa (the "Visa Agreement");

(s)            under the terms of the Visa Agreement the Appellant was assigned an account number;

(t)             the Visa Agreement established the terms of the relationship between the bank and the Appellant, including the Discount Fees and the deposit procedures;

(u)            the Appellant also entered into similar agreements with the Bank of Montreal and/or another financial institution for direct deposit (debit card) transactions (the "Debit Card Agreement");

(v)            under the terms of the Debit Card Agreement the Appellant was assigned an account number;

(w)           the Debit Card Agreement established the terms of the relationship between the bank and the Appellant, including the Discount Fees and the deposit procedures;

(x)             if a Member wished to take advantage of the terms the Appellant had negotiated in the MasterCard Agreement, the Visa Agreement and/or the Debit Card Agreement the Member had to inform the Appellant;

(y)            the notification referred to in the previous subparagraph required the Member to say whether it wished to participate in the MasterCard Agreement, the Visa Agreement and/or the Debit Card Agreement and who it wanted to supply the point of sale equipment;

(z)             once the Appellant received the information referred to in the previous subparagraph it requested under its signature that the appropriate bank of banks assign that Member a merchant number "as part of the NWD chain" (i.e. under the Appellant's account number);

(aa)          upon receipt of the request made by the Appellant, the bank or banks would contact the Member, determine if the Member should be given a merchant number and, if so entered into agreements with the Member and informed the Appellant of the Member's merchant number;

(bb)          for electronic MasterCard, Visa or Debit Card transactions, the Member processed the transaction at its store and the bank deposited the funds from the transaction into the Appellant's account, cross-referencing the Member's merchant number;

(cc)          for paper MasterCard or Visa transactions the Member forwarded the credit card slips to the Appellant, who deposited them into its account, cross referencing the Member's merchant number;

(dd)          using the cross referenced merchant numbers the Appellant applied the funds it received from MasterCard, Visa and debit cards to the Member's trade account;

(ee)          the banks withdrew the Discount Fees from the Appellant's accounts;

(ff)            the Appellant charged the Members program fees, which included a portion of the Discount Fees; and

(gg)          the fees referred to in the above paragraph were charged to the Member's trade account monthly/periodically.

The Appellant also disputes the alternative basis for the assessments set out in paragraph 13 of each Reply:

In the alternative, it is submitted that to the extent that the Appellant's activities fall within the definition of "financial services" in section 123 of the Act then such activities are incidental to the provision of the main supplies of the Appellant, namely providing property to the stores.

[4]            Mr. David Hamanaka was comptroller of the Appellant during the period covered by these assessments. He was fully familiar with the Appellant's business, and in particular with that aspect of it relating to the arrangements among the Appellant, its member stores and the Bank of Montreal (B of M) and the Toronto-Dominion Bank (TD Bank) relating to the use of credit and debit cards in the customers' stores. He identified the form of agreement which the Appellant enters into with every drugstore joining the I.D.A. group, and the relevant extracts from the I.D.A. Program Guidebook and the Profit Smart I.D.A. Store Operations Guide. All of these govern the relationship between the Appellant and its member stores. He also identified the MasterCard Major Merchant Agreement (MMM Agreement) which was signed by the Appellant and the B of M. This agreement is 28 pages in length, and is apparently in the bank's standard form for use with multi-branch retailers to govern the terms on which they use the bank's MasterCard credit facilities in their retail outlets. It is important to note that this form throughout its 28 pages contemplates a contract between the bank and a merchant conducting a retail business. It is clear from the evidence of Mr. Hamanaka, which I accept, that the Appellant did not conduct any retail business itself; it sold product to the member drugstores, and they in turn retailed to the public. I infer that when the Appellant and the bank concluded negotiations and arrived at an agreement whereby the Appellant's member stores could use the bank's MasterCard facilities at a rate more favourable than those stores could have obtained individually, then the agreement was recorded on this bank form as a matter of convenience, even though it is totally inappropriate for that purpose. Neither party could have contemplated that the Appellant would make retail sales, and so almost all the provisions in those 28 pages are redundant. What is not redundant is paragraph 5, titled "Discounts and Fees", which provides the rates of discount on MasterCard sales and the monthly fees for imprinters and terminals which the merchant is obliged to pay to the bank. Although the parties agree that this "agreement" was entered into between the Appellant and the bank, it is clear that it was not the Appellant, but its member stores, that paid these discounts and fees. In my view, this "agreement" does not create a contractual relationship between the bank and the Appellant, or between the bank and the stores.

[5]            Mr. Hamanaka testified that when a member merchant, that is to say an I.D.A. drugstore, indicates to the Appellant that it wishes to make the use of the MasterCard system available to its customers, the Appellant then forwards to the bank a request to establish a "MasterCard merchant number" for that retailer. The bank then enters into a separate contract with that retailer to govern the use of the MasterCard system at that member's store, at the rate of discount and monthly equipment charge which the Appellant has negotiated for all its members. The same procedure was followed at the relevant time for both the MasterCard system provided through the B of M, for the Visa system provided through the TD Bank, and for the debit card system which was also provided through the TD Bank. Copies of the printed forms used by the TD Bank for the agreements with individual retailers are contained in Exhibit A-1. Unfortunately, they are almost illegible, and the forms used by the B of M were not produced at all. However, I conclude on the basis of the documents that were entered, and the evidence of Mr. Hamanaka, that each retailer who made use of the credit and debit card facilities provided by the two banks did so pursuant to individual contracts entered into between themselves and the banks, and that the only purpose of the MMM Agreement which the Appellant signed was to record the rates that the Appellant had negotiated as a service to its members.

[6]            Mr. Hamanaka went on to describe the procedure by which credit and debit card payments and charges are processed, referring to certain extracts from the Appellant's ledgers to illustrate. When a customer pays for a purchase at an I.D.A. store with a credit card, the bank debits the customer's MasterCard or Visa account and credits the bank account of the Appellant. The Appellant in turn credits the trade account of the store at which the sale took place. If a purchase is returned then the transactions are reversed; the bank credits the customer and debits the Appellant's bank account, and the Appellant debits the store's trade account. Monthly charges for each store are processed automatically by the bank, which debits the Appellant's bank account. The Appellant passes on these debits to individual stores' trade accounts. To enable the Appellant to make the appropriate credit and debit entries to the trade accounts of its members, the bank provides it with summaries of all the transactions for each store. The procedure followed is essentially the same whether the retail sale is by MasterCard, Visa, or debit card. Mr. Hamanaka's evidence was unchallenged, and I find that it accurately describes what occurs among the Appellant, its members and the banks. It is important to note, however, that these procedures are not set out in either the MMM Agreement or the individual agreements between the stores and banks.

[7]            There are obvious benefits for all parties in these arrangements. The banks obtain the credit and debit card business of virtually all the member stores in the chain. The stores get the benefit of access to credit and debit card services from the banks on terms that have been negotiated from the strength of numbers. The Appellant has the benefit of receiving the cash flow from the credit and debit card sales in the retail stores, thereby reducing its accounts receivable.

[8]            I turn now to those assumptions of fact which are disputed.

12(e)       at all material times the Appellant was a wholesaler/retailer engaged in the business of making supplies to drug stores, general stores, hospitals, clinics, veterinarians and farmers;

...

(m)           the membership agreement did not specifically refer to any arrangements the Appellant had made with the financial institutions;

(n)           the Members did not provide express or implied consent to the Appellant for the Appellant to act as their agent;

...

(q)           the MasterCard Agreement established the terms of the relationship between the Bank of Montreal and the Appellant, including the Discount Fees and the deposit procedures;

...

(ff)            the Appellant charged the Members program fees, which included a portion of the Discount Fees;

[9]            12(e) is simply wrong as to the important statement that the Appellant is a retailer. It makes some sales directly to hospitals, clinics and other health care groups, but they are not related to the matters with which these appeals are concerned. It makes no sales to the general public, and the matters in issue here relate entirely to sales by retailers which are customers of the Appellant at the wholesale level.

[10]          12(m) and (n) assert that the membership agreement did not refer to any arrangement made by the Appellant with the banks, and that the member stores neither expressly or impliedly consented to the Appellant acting as their agent. The Appellant negotiated rates for the credit and debit card services with the banks, and the members were free to avail themselves of those rates if they chose to do so. The Appellant did not purport to bind the members to any agreement with the banks, however. There is no specific mention of these negotiated rates in the membership agreement. However the I.D.A. Program Guidebook, which is contemplated by the membership agreement, states that

I.D.A. has established an agreement with the Bank of Montreal where, based on the power of the collective entity, significant savings can be achieved in both the chargecard discount rates as well as the related equipment rental.

The Bank of Montreal has been chosen as the 'Value Added Supplier' because of the completeness of their offering – particularly the inclusion of the new 'Debit Card'.

It then goes on to set out the services and terms which are available to the member stores as a result of the negotiation.

[11]          12(q) is simply not correct on the evidence before me. The MMM Agreement does not speak at all to the deposit procedures. Nor does it create a contract. In my opinion it does no more than record the rates at which the bank is willing to enter into contracts with the individual stores.

[12]          In paragraph 12(ff) the Minister asserts that the Appellant charged program fees to the member stores, and that these fees included a portion of the "Discount Fees", that is to say the fees paid to the banks for credit and debit card services. I am satisfied that the program fees did not include any amount, or any portion of an amount, that was paid by the Appellant to the banks. However, under the arrangement described by Mr. Hamanaka, the banks did charge the "Discount Fees" to the Appellant's accounts at the banks, and the Appellant in turn debited the members. In doing so, it acted as the agent of the members for the purpose of making the payments on their behalf to the banks.

[13]          The position of the Minister as to the basis of these assessments is set out in paragraphs 14 to 30 and 33 and 34 of the written argument filed after the oral hearing. I reproduce them here in their entirety, as they defy both condensation and comprehension.

14.            At issue in these appeals is the tax status of credit card discount fees and debit card processing fees (referred to above and hereinafter as the "Discount Fees") which the Appellant charged to its customers, merchant members of programs the Appellant administered (i.e. IDA).

15.            The Appellant was assessed GST collectible on these fees on the basis that they were consideration for a taxable administrative service (processing and debt collection).

16.            Taxable supply is defined under section 123 of the Excises Tax Act (referred to above and hereinafter as the "Act", as being a supply made in the course of a commercial activity.

17.            Commercial activity of a person is defined as a business carried on by a person except to the extent to which the business involves the making of exempt supplies.

                                Section 123 of the Act.

18.            It is submitted that the Appellant was not providing the same service as financial institutions do in providing for credit and debit card facilities and therefore the Appellant was not exempt under subsection 123(1) of the Act.

19.            The Appellant entered into the MasterCard, Visa and Debit card agreements on its own behalf. These agreements could not be assigned without the financial institution's approval and that the Appellant had not assigned its rights and obligations under the agreements to the Members.

                                Exhibit A-1 Tab 4

20.            Also, it is submitted that, in addition to lower Discount Fees, the Appellant benefited from the procedures established under each of the Agreements as the financial institutions deposited the money payable by the cardholders directly into the Appellant's account and the Appellant used those funds to reduce the amounts owed by each of the Members on its trade account.

21.            Furthermore, it is submitted that the Appellant was not arranging for a service referred to in paragraphs (a) to (i) of the definition of financial service in subsection 123(1) of the Act whenever a Member wished to take advantage of the terms of the Appellant's MasterCard, Visa and Debit Agreements. Instead, the Appellant collected the information from the Member and transferred that information to the financial institution.

22.            Furthermore, once the financial institution received the transferred information from the Appellant, the financial institution took whatever steps were necessary to approve the Member for a merchant's number and to arrange the financial service, including entering into any necessary agreements with the Member.

                                (Exhibit A-1 Tab 5)

23.            Consequently, it is submitted that the Appellant was not a "person at risk" as that term is defined in subsection 4(1) to the Financial Services (GST) Regulations (the "Regulations") and that the service the Appellant provided to the Member was, therefore, excluded from the definition of financial service as it was a prescribed service pursuant to paragraph (t) of the definition,

24.            Likewise, it is submitted that the service the Appellant supplied to the Members when it received the funds from the financial institutions for the credit and debit card transactions was excluded from the definition of financial service as it was a prescribed service pursuant to paragraph (t) of the definition as the Appellant provided an administrative service to the Members by applying those funds to each Member's trade account with the Appellant and the Appellant was not a "person at risk".

25.            The facts of the Appellant's case are not identical to the facts in Skylink Voyages Inc. v. The Queen. Contrary to the situation in Skylink, in this case each of the Merchant Members entered into an agreement on its own behalf with the financial institutions. In Skylink the retail agency had no agreement with the issuer of the credit card used by its customer.

                                Exhibit A-1 Tab 5

26.            Furthermore, it is submitted that the Appellant was not financially at risk as was Skylink. In this case, the Appellant's risk was no greater than the risk of selling its goods on account. The Appellant was not a person who was financially at risk by virtue of the acquisition, ownership or issuance of the financial instrument.

27.            Under section 178 of the Act, as it read at the time:

                                For the purposes of this Part, where in making a supply of a service a person incurs an expense for which the person is reimbursed by the recipient of the supply, the reimbursement shall be deemed to be part of the consideration for the supply of the service, except to the extent that the expense was incurred by the person as an agent of the recipient.

28.            It is submitted that the Appellant was not acting as the Member's agent. Each of the Members who benefited from the terms of the Appellant's MasterCard Agreement, Visa Agreement and Debit Card Agreement:

                (a)            entered into an agreement on its own behalf with the financial institution;

                (b)            received a merchant number "as part of the NWD chain";

                (c)            was not assigned the Appellant's rights and obligations under the MasterCard, Visa and Debit Card Agreements; and

                (d)            did not give the Appellant express or implied authority to act as its agent.

                                Glengarry Bingo Association v. The Queen, (Respondent's Book of Authorities; Tabs 2 and 3)

29.            Therefore, it is submitted that, as the service the Appellant provided to the Members under the membership agreements were not financial services pursuant to subsection 123(1) of the Act, and as the Appellant was not acting as the Members' agent, the Appellant was required by section 178 of the Act, as it read at the time, to include the amounts it was reimbursed for the Discount Fees, as part of the consideration for its supplies of services that were taxable at 7%.

30.            Consequently, it is submitted that the Appellant failed to account for tax that it was required to collect and account for, pursuant to sections 221(1), 225(1) and 228 of the Act, on the supplies it made to the Members during the relevant periods.

...

33.            In the alternative, it is submitted that to the extent that the Appellant's activities fall within the definition of "financial services" in section 123 of the Act, then such activities are incidental to the provision of the main supplies of the Appellant, are supplied together with the Appellant's taxable supplies for a single consideration and are deemed by section 138 of the Act to form part of the main supplies of the Appellant.

                                Locator of Missing Heirs Inc. v. The Queen – Respondent's Book of Authorities Tab 1.

34.            It is submitted that the activities of the Appellant in issue were supplied together with the Appellant's taxable supplies for a single consideration, as demonstrated by the Appellants documents at Exhibit A-1 Tab 7, pp. 5, 12 and 13. The Appellant provided the Merchant Members with a single statement in respect of the consideration.

[14]          Although neither the pleadings nor the evidence makes it at all clear, it appears that the Minister must have assessed tax on the total of the fees paid by the Appellant to the banks on behalf of its members.[2]

[15]          The Appellant takes the position that these amounts are not taxable because they fit within the definition of "financial services" found in subsection 123(1) of the Act, and also on the basis that the Appellant simply acted as an intermediary in arranging for the provision of exempt financial services to the member stores.

[16]          In an early value-added tax case Lord Denning pointed out the importance of asking, and answering, the question "what did the [supplier] supply in consideration of the £ 1.50 they received?"[3] Soon after, Lord Widgery C.J. added this:[4]

I would only wish to repeat what I said in one of the earlier cases, and that is to hope that when answering Lord Denning MR's question in the future in this type of case people do approach the problem in substance and reality. I think it would be a great pity if we allowed this subject to become over-legalistic and over-dressed with legal authorities when, to my mind, once one has got the question posed, the answer should be supplied by a little common sense and concern for what is done in real life and not what is, as Cumming-Bruce L.J. put it, too artificial to be recognized in any context.

In the present case the assessor seems not to have asked, or answered, Lord Denning's question. Nor did either the oral or the written arguments of counsel provide an answer. This is unfortunate because, in my view, when the question is asked the answer is, as Lord Widgery suggests, supplied by the application of a little common sense.

[17]          What then, did the Appellant supply? Its main supply to the member stores is goods, and on those it collects and remits GST. It also supplies such services as promotion, the right to use trademarks and the like, for which it charges the members a fee and which is no doubt subject to GST. In the context of these appeals, what it supplied was, first, the service of negotiating the favourable discount rates and rental rates with the banks for its members. In addition, it received payments from the banks and made payments to them for its members. What the Appellant did not do was to supply, or resupply, credit and debit card services to its member stores. It is the banks, not the Appellant, that have the equipment and the organization to supply these services, and they are not commodities like bandages or sunglasses that the Appellant could buy and resell. Moreover, as I have said above, the Appellant did not enter into a contract with the bank.

[18]          There was no evidence suggesting that the Appellant received any consideration specific to the service of negotiating the terms to be made available by the banks to the member stores. That was simply one of a number of services it provided to them as part of the program, the consideration for which was the program fees referred to in paragraph 12(ff) of the Replies. As I have already found, no part of the discount fees is added to or contained within these program fees. Although there was no evidence on the point, I assume that GST is collected and remitted by the Appellant on the program fees. The Appellant did not suggest that any part of those fees should be exempt as being for a financial service. If any part could be so identified, it would be caught by section 138 as an incidental supply.

[19]          I turn now to the second part of the service in issue. It is common ground between the parties that, because of the terms in which subsection 123(1) of the Act defines the expressions "taxable supply" and "commercial activity", and because financial services are exempt under Schedule V, Part VII, tax is not exigible on financial services. This service clearly falls within clause (a) of the definition of "financial service" in section 123:

"financial service" means

                (a)            the exchange, payment, issue, receipt or transfer of money, whether effected by the exchange of currency, by crediting or debiting accounts or otherwise.

The words I have italicized describe the function the Appellant performs.

[20]          The Respondent argues that the service is removed from the ambit of the definition by the operation of the Financial Services (GST) Regulations.[5] These Regulations define certain prescribed services which are not to be included in the definition of "financial services". The relevant part is section 4:

4(1)          In this section,

                "instrument" means money, an account, a credit card voucher, a charge card voucher or a financial instrument;

                "person at risk", in respect of an instrument in relation to which a service referred to in subsection (2) is provided, means a person who is financially at risk by virtue of the acquisition, ownership or issuance by that person of the instrument or of a guarantee, an acceptance or an indemnity in respect of that instrument.

4(2)          Subject to subsection (3), the following services, other than a service described in section 3, are prescribed for the purposes of paragraph (t) of the definition "financial service" in subsection 123(1) of the Act:

                (a)           the transfer, collection or processing of information, and

                (b)           any administrative service, including an administrative service in relation to the payment or receipt of dividends, interest, principal, claims, benefits or other amounts, other than solely the making of the payment or the taking of the receipt.

4(3)          A service referred to in subsection (2) is not a prescribed service for the purposes of paragraph (t) of the definition "financial service" in subsection 123(1) of the Act where the service is supplied with respect to an instrument by

                (a)           a person at risk,

                (b)           a person that is closely related to a person at risk, where the recipient of the service is not the person at risk or another person closely related to the person at risk, or

                (c)            an agent, salesperson or broker who transfers ownership of the instrument for a person at risk or a person closely related to the person at risk.

The concluding words of paragraph 4(2)(b) which I have italicized clearly apply to the second part of the services the Appellant supplied and exclude them from the category of "prescribed services" which in turn are excluded from the definition of "financial services".[6]

[21]          There is no consideration that has been identified as having been paid for these services. Indeed it might be argued that the making of payments and taking of receipts is as much a service to the Appellant itself as to its members, considering that the Appellant has the benefit of an accelerated cash flow against its accounts receivable. In either event, there is no service to the members that is not a financial, and therefore exempt, service. As with the negotiation of the rate, to the extent that there is a consideration for this service within the membership fees it would be subject to tax, and has been taxed, under section 138.

[22]          There was some evidence suggesting that when credit card charges were processed on paper rather than electronically, the vouchers are forwarded by the stores to the Appellant and deposited by the Appellant at the appropriate bank as cash would be. As neither counsel made any distinction between electronic and paper transfers in the course of the argument, I see no reason to treat them differently in these Reasons.

[23]          The appeals are therefore allowed, and the assessments are referred back to the Minister for reconsideration and reassessment on the basis that the amounts assessed as "GST collectible on Visa and MasterCard charges resupplied to customers" and as "GST collectible on the resupply of credit card charges to account receivable" are not subject to tax. The penalties and interest will, of course, be cancelled as well. As the amount of tax in dispute under each assessment exceeds $7,000, I cannot make any award of costs.[7]

Signed at Ottawa, Canada, this 5th day of April, 2001.

"E.A. Bowie"

J.T.C.C.

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