Tax implications for rewarding clients

Customer loyalty and reward programmes spanning the commercial spectrum abound. These schemes are aimed at attracting and retaining customers. Retailers, telecoms companies, airlines, hotels, fuel stations, credit card issuers, among others, are in it.

Though each scheme is unique, the common denominator is earning points every time of purchase to be redeemed for merchandise, services, cash, and so on.

Given the evolution of these programmes, the tax accounting treatment of these programmes has been and will continue to be the subject of controversy and uncertainty because the difference in how these are treated for financial reporting (which treatment may result in the recognition of a liability) and how these are treated for tax purposes.

When considered for an accounting perspective, a customer under a loyalty and award programme is implicitly paying for the right to receive goods or services in the future and thus the business running the programme receives consideration for separately identifiable components of the initial transaction.

That is, the sale of the initial supply and a further performance obligation to supply goods or services.

When an entity that runs such a programme receives payment for selling something, part of the consideration received for the initial sale should be allocated to the award credits and recognised as a liability until the entity awards credits to the customer.

Once a customer redeems, the entity then satisfies its performance obligation of delivering the goods or services and should consequently recognise the revenue that was initially deferred as a liability.

Notwithstanding the accepted accounting approach above, the tax implications resulting from such programmes in the hands of the entity running the programme and the customer earning the awards would not follow this treatment as taxation legislation forms its own specific guidelines from the perspective of income tax as well as VAT.

Remember that the taxman prefers to get his money sooner rather than later, while the taxpayer would like to defer any payment – time value of money - tax disputes arise on the timing of these tax consequences and more particularly when they should crystalise.

I should, therefore, clarify that the bone of contention is not necessarily whether or not such programmes give rise to tax implications.

With regard to income tax, where a taxpayer seeks to claim a deduction for expenditure paid to another, the latter should treat the corresponding receipt as his income which means that where one taxpayer enjoys the benefit of a reduction in his taxable income due to a deduction, another suffers the burden of a higher taxable income due to higher earnings.

Therefore, prima facie, the earning of award points under a loyalty programme could potentially constitute a receipt or accrual of income.

This is due to the fact that a customer under a loyalty programme would pay exactly the same amount for the goods or services as any other customer not belonging to that loyalty programme.

But for incurring the same expenses a customer under the programme is accruing a right which he can use later.

However, given the rather narrow definition of what constitutes taxable income under the current income tax law and amounts involved, such income could legitimately escape the tax noose.

There is general consensus that these schemes do give rise to tax implications for the recipients of the loyalty awards (who could potentially have taxable income) and the entities running the programmes (who treat these awards as deductible expenses).

Therefore, when it comes to expenses, the question is when entity running the programme should recognise a deduction for tax purposes.

There are income tax, VAT and potential PAYE implications for a customer loyalty and reward programme and it is key to consider all these implications if you are running such a programme or if you have enrolled for such a programme.