l EDITED BY WALTER HELLERSTEIN, J.D. STATE & LOCAL

Sales and Use Tax Implications of Loyalty Programs

MARY T. BENTON, MATTHEW P. HEDSTROM, AND GREGG D. BARTON

Examining a reward’s form, structure, and parameters is essential for determining the state sales and use tax consequences.

In today’s competitive consumer en - ward programs, but loyalty programs vironment, loyalty programs are predate these programs and have ac - ubiquitous with the shopping expe - tually been around for more than 100 rience. Most companies offer some years. 3 One of the earliest loyalty pro - form of a “loyalty” or “reward” pro - grams was the S&H Green Stamps gram. When consumer spending program, which began in the 1930s. 4 slowed as a result of the economic Under that program, consumers re - downturn, consumer loyalty, and ceived stamps when making pur - with it, loyalty programs, became chases, collected those stamps in a even more important. For example, booklet and later redeemed the book - according to Jupiter Research, more let for products when the consumer than 75% of consumers today have accumulated the requisite number of at least one loyalty card, and the stamps. In essence, the booklet func - number of people with two or more tioned as an alternative for a is estimated to be one-third of the having a certain associated value. shopping population. 1 And loyalty While the general premise of the programs are big —according S&H Green Stamps program is still to Forbes in an article published in applicable today, loyalty programs 2011, “U.S. companies spend $50 bil - have evolved considerably from the lion a year on [various] loyalty pro - trading stamps model. And while air - grams. And when done right, loyalty line frequent flyer programs still exist programs can generate as much as 20 today, current loyalty programs are percent of a company’s profits.” 2 varied, significantly more complex, Many can trace back their aware - structurally diverse, and constantly ness of loyalty programs to airline fre - evolving. State tax laws, on the other quent flyer programs and hotel re - hand, have not, in many instances,

80 l JoUrnaL of TaxaTIo n l aUgUST 2015 kept up with the evolution of loyalty reward programs. As noted, the re - form. Even where similarities exist, de - programs from a business perspective. wards themselves are offered in any termining the amount of “considera - As a result, taxpayers are often left to number of forms, including but not tion” paid in connection with a par - apply historic precedent to modern- limited to, cards, points, certificates, ticular sale when the redemption of a day loyalty programs with varying vouchers, credits, codes, and . loyalty reward is involved is not al - degrees of success, depending on the The business-to-business industry ways clear. Essentially, the question particular program and the applicable has also developed in this area becomes, does the provision of a re - state law. Adding further challenge, whereby third-party instruments are ward constitute taxable considera - state laws are not uniform; thus, in used to “fund” the retailers’ programs, tion? addition to applying old precedent, or to augment them. Often the most analogous guid - taxpayers have to contend with ap - While there are several discrete ance is found in the context. plying non-uniform laws and inter - sales and use tax issues that arise in The typical sales and use tax scheme pretative guidance to their facts, which connection with an analysis of a loy - employed across the country draws a can result in different conclusions alty program, the most common issue distinction first between coupons and across states, even in states with iden - and the one that will be examined in general price reductions, and a further tical or substantially similar statutes. this article relates to the ramification distinction between retailer coupons of the redemption of an award in ex - and manufacturer coupons. With re - change for a taxable item. Specifically, gard to purchase price reductions, “[a] LOYALTY when rewards are exchanged for dis - cash discount given by the seller at PROGRAMS GENERALLY counts on the sale of tangible personal the time of the sale, and not depend - Very generally, loyalty programs are property, is the value of the reward ent on time of payment, volume of incentive-based programs whereby a considered part of the “sales price” purchases, or similar factors, is usually company offers rewards, vouchers or subject to the tax? The form of the re - excluded from the sales tax base, on similar instruments in exchange/con - ward, the program’s structure and the the ground that the discount is not sideration of certain consumer behav - parameters of the reward are critically part of the sales price.” 7 When ior (e.g., purchasing, referrals, etc.) that important in analyzing the state sales “coupons” are involved, most sales can be applied toward future pur - and use tax consequences. 5 and use tax schemes draw a distinc - chases of products/services offered by tion between: (1) coupons issued by the company (or an affiliate) (gener - the retailer to the customer for which ally for purposes of this article such CONSIDERATION the retailer is not reimbursed (by the programs will be referred to as “loy - PAID AND THE manufacturer or any other third alty programs” and the associated re - DEFINITION OF SALES PRICE party), and (2) manufacturer coupons wards as “loyalty rewards”). Programs As a general matter, sales tax is im - for which the retailer is reimbursed are also offered by service providers, posed on the “sales price” of a taxable (by the manufacturer or other third including airlines, spas, gyms, and item. While the relevant statutory party). 8 Across the country, it is restaurants, to name a few. However, terms may vary, the concept is the “widely held that discount coupons it is hard to generalize as to the struc - same; tax is imposed on a statutorily- for which retailers are not reimbursed ture of loyalty programs and it would defined base, be it “sales price,” “re - by a manufacturer or other person be unwise to do so, as today’s loyalty ceipts,” or “gross receipts.” That statu - serve to reduce the sales tax measure.” 9 programs are structured in a variety tory definition typically refers to the In contrast, manufacturer’s coupons of ways. Usually these programs entail total amount of “consideration” paid “which reduce the sales price to the “rewarding” certain consumer behav - for the taxable item. By way of exam - consumer but for which the retailer iors, including, rewarding prior pur - ple, the Streamlined Sales and Use Tax is reimbursed by the manufacturer or chases, incentivizing future purchases, Agreement broadly defines “sales distributor, are usually held not to re - rewarding the completion of a survey, price” as the “total amount of consid - duce the state’s sales tax measure” on referring a friend, and hosting events eration … for which personal prop - the theory that the retailer’s receipts with the loyalty program sponsor, by erty or services are sold, leased, or include both what it receives from the way of examples. rented.” 6 However, state definitions of customer and what it receives from Loyalty programs are also offered “receipts” or similar terms are not uni - the manufacturer or distributor. 10 through third party arrangements (i.e., NOTES offered by a third party different than 5 for additional background, see Hellerstein and Heller - 1 www.forbes.com/2007/01/02/frequent-flyer-miles-ent- stein, State Taxation (Thomson reuters, 1998), the one with whom it will be re - sales-cx_kw_0102whartonloyalty.html. ¶ 17.06[6]. 2 www.forbes.com/sites/mckinsey/2011/12/01/loyalty-is- deemed). Such programs are often 6 SSUTa appendix C, Part I. it-really-working-for-you/. structured as reward pro - 7 See Hellerstein, State Taxation , ¶ 17.05[1]. 3 www.forbes.com/2007/01/02/frequent-flyer-miles-ent- 8 grams, rewards sponsored by the re - sales-cx_kw_0102whartonloyalty.html. Id ., ¶ 17.05[2]. 9 lated affiliate, franchisee-operated 4 www.forbes.com/2007/01/02/frequent-flyer-miles-ent- Id ., ¶ 17.05[2][a]. programs, and employee-sponsored sales-cx_kw_0102whartonloyalty.html. 10 Id ., ¶ 17.05[2][b].

STaTe & LoCaL aUgUST 2015 l JoUrnaL of TaxaTIon l 81 The distinction between manufac - taxpayers must consider the guidance ment considered whether points turer and retailer coupons is often ad - in determining whether certain loyalty earned in connection with Intercon - dressed by revenue departments in rewards would be considered taxable tinental Hotel Group’s (IHG) reward regulation and informal or formal consideration. program were subject to sales tax. guidance. Despite the widespread Similar to other states, New York After accumulating enough points, adoption of the distinction between has followed the “coupon” framework reward members would redeem retailer coupons and manufacturer in analyzing reward programs —at points through IHG for free hotel coupons and the general conclusion least as applied to certain fact patterns. stays. IHG would then mail the that one such coupon is properly New York has addressed the sales and member a voucher which instructed viewed as “consideration,” applying use tax consequences of using “store the member to contact IHG. IHG that framework to other fact patterns, loyalty cards” through informal guid - would arrange for the hotel stay at especially in the rewards context, ance. 13 In that guidance, the Depart - the participating hotel. IHG would leads to inconsistent and often unsat - ment of Taxation and Finance (the then pay each franchisee hotel a cer - isfying results. 11 Indeed, the coupon “Department”) has taken the position tain amount to “reimburse” the hotel framework is routinely applied to new that the impact of the use of the loy - for the stay. The Department con - fact patterns, which have the appear - alty card will be determined by ap - cluded that the hotel at issue was re - ance of being similar, but are never - plying the principles applicable to quired to collect tax on the amount theless not a perfect fit, often resulting coupons —that is, if the retailer is re - paid to the hotel by IHG, which es - in litigation. imbursed for the discount, the full sentially included the value of re - selling price will be subject to tax. 14 In deemed points. 17 this regard, New York generally fol - The New York State Tax Appeals DIFFERENT STATES, lows the Streamlined treatment: the Tribunal came to the opposite con - DIFFERENT RESULTS? impact on the amount of taxable “re - clusion, in Matter of Marriott Inter - Taxpayers are faced with the reality ceipts” associated with the customer’s national, Inc.. , DTA No. 821078 (N.Y. that state sales and use tax statutes, purchase depends on whether the Tax. App. Trib., 1/14/10) and effec - regulations and informal guidance of - coupon is funded by the retailer or tively revoked the Department’s opin - ten do not adequately address how by the manufacturer of the item being ion in Turf House, Inc./Holiday Inn. to tax the purchase of taxable goods purchased. 15 The rationale being that The Tribunal found that the members through the redemption of a loyalty the tax is imposed on the total receipts previously provided the consideration reward. A survey of three states, New received by the vendor, whether those for occupancy of the hotel rooms by York, and Washington bear out this reality. There are many types of loyalty New York programs, and a ruling related to the Similar to the Streamlined Sales and l taxation of one program may not Use Tax Agreement, New York defines “receipt” for sales tax purposes as: necessarily be relevant to how the “The amount of the sale price of any redemption of loyalty rewards pursuant property … valued in , to another program should be treated. whether received in money or other - wise , including any amount for which credit is allowed by the vendor to the receipts come wholly from the pur - earning rewards, and since full sales purchaser….” 12 While arguably expan - chaser or partly from the purchaser taxes were paid by the member on sive, the definition does not always and partly from the manufacturer. 16 the initial point-earning stays, no fur - provide a satisfactory answer as to The framework, however, is not ther sales taxes needed to be collected whether the provision of a loyalty re - always easy to apply to a compli - when the hotels were reimbursed for ward would constitute a “receipt” for cated loyalty program fact pattern. those stays. 18 The Tribunal, in agreeing sales tax purposes. Is such a reward Consider, for example, the treatment with the Administrative Law Judge, “valued in money”? Is it “considera - of a hotel rewards program under concluded that the amounts were ac - tion”? Or is it a “coupon” of sorts? New York law. New York addressed tually “reimbursements to [the hotels] New York is a state that has some a form of reward program in Turf for their periodic contributions to [the guidance related to loyalty programs, House, Inc./Holiday Inn, TSB-A- reward program].” The hotels argued so in addition to applying the statute, 04(19), 9/2/04, in which the Depart - that the reimbursements received are not consideration for occupancy in a hotel. The state, on the other hand, MarY T. BenTon is a partner at alston & Bird LLP in atlanta, MaTTHeW P. HeDSTroM is a senior as - sociate at alston & Bird LLP in new York City, and gregg D. BarTon is a partner at Perkins Coie LLP maintained that hotels received con - in Seattle. Copyright © 2015, Mary T. Benton, Matthew P. Hedstrom, and gregg D. Barton. sideration for the occupancy from

82 l JoUrnaL of TaxaTIo n l aUgUST 2015 STaTe & LoCaL Marriott Rewards in the form of re - by petitioners, a central difference is that at issue, especially where such a pro - wards points. under the rule, the tax is gram involves a third-party or mul - collected from the individual who re - The ALJ stated that the reimburse - deemed the stamps. In contrast, here the tiple third parties. Further, it is not ment to the hotels: Division is not seeking to collect the tax clear the extent to which a taxpayer [d]id not entitle Marriott Rewards to the sought on the discounted room from the may look to guidance dealing with right to occupy a room or the right to hotel patron. Rather, it is trying to collect the tax from Marriott Rewards. It follows one type of program to analyze a distribute a room. It follows that the re - slightly different program. The pres - imbursement was not consideration for that the trading stamp rule is not relevant 20 hotel occupancy. Rather the method of to this matter.” ence of material or immaterial factual payment supports the finding, as asserted differences could lead to vastly differ - by petitioners, that the Rewards Program ent tax results. Indeed, a pure/unprin - was designed to reimburse the hotel for What is entirely participation in the Marriott Rewards clear is that the cipled application of the “trading Program which, in turn, was a marketing l stamp” rule would have rendered the tool intended to increase stays at Marriott states differ in Marriott reward program taxable. 21 Hotels. Therefore, the consideration re - their ceived by the hotels from Marriott Re - wards is not subject to sales tax. The con - approaches. Georgia sideration for the occupancy of the hotel Thus, there is no Georgia is an example of a state that room was, in fact, provided by the cus - does not have any direct guidance re - tomer who usually earned the points “one size fits all” through previous lodgings at Marriott answer for lated to loyalty programs. Thus, in or - hotels ….The Division notes that if there taxpayers. der to analyze whether loyalty re - is no occupancy, there was no payment. wards would be considered taxable This argument is without merit because consideration in Georgia, one would it fails to recognize that it would be erro - neous to tax a transaction as considera - One could presumably apply the begin with the statutory definitions of tion for a stay in a hotel room when the logic in the Marriott decision to other “sales price” and then review the ex - primary purpose of the payment was re - loyalty programs —airline miles, hotel isting regulations and case law, which imbursement for participation in a pro - rewards, retailer rewards, etc.—how - deal primarily with trading stamps. gram which was a marketing program to promote stays in a hotel. The fact that the ever, as the case makes clear, the pro - Georgia sales/use tax is imposed hotels are reimbursed according to a for - gram’s underlying structure is critical on the “sales price” of taxable tangible mula that factors in occupancy does not to the analysis, and loyalty program and services. Geor - alter this conclusion. 19 structures vary. Clearly, a key question gia defines “sales price” as “the total Interestingly, the ALJ distinguished in New York is whether the entity amount of consideration, including the case from the “trading stamp” rule, providing the taxable good or service cash, credit, property, and services, for stating that the redemption of trading at issue receives “reimbursement” or which personal property or services stamps for tangible personal property “consideration” in connection with re - are sold, leased, or rented, valued in is subject to sales tax, which the state demption of a loyalty reward. As the money, whether received in money or argued applied. The ALJ concluded that: above suggests, an answer to this otherwise without [certain deduc - [t]he application of this rule to the issue question may be quite difficult, de - tions].” 22 Like many other states, Geor - presented here is dubious. As pointed out pending on the nature of the program gia excludes from the definition of

NOTES 11 By way of example, guidance issued in connection ceives no reimbursement from a third party for statutory language defining “receipt” as consisting of with the sales and use taxation of “discount vouchers” the amount of the discount given, it is a store dis - the sale price “valued in money, whether received in offered by internet-based social coupon programs count.”). money or otherwise .” focused on this type of analysis with mixed success. 15 See 20 nYCrr § 526.5. 17 Compare with nYC finance Memorandum 06-2 for an overview of the issue see e.g., “Social Confu - 16 for a more recent example, see In the Matter of GRJH, (11/30/06). sion: How Do Sales Taxes apply To a groupon?,” Inc ., DTa no. 825192 (n.Y. Div. Tax app., 1/15/15) in which 18 The program in the Marriott case worked similarly to www.forbes.com/sites/janetnovack/2011/02/18/social- the Division of Tax appeals considered whether the the IHg program at issue in Turf House, Inc./Holiday confusion-how-do-sales-taxes-apply-to-a-groupon/ taxpayer was required to include in its taxable receipts Inn . (2/18/11). the sale of gasoline that was reimbursed by a third- 19 emphasis added, internal citations omitted. 12 n.Y. Tax Law § 1101(b)(3) (emphasis added); see also party provider pursuant to a rewards program. The 20 for another example of the Department veering from 20 nYCrr § 526.5. The definition of “complimentary taxpayer was in the business of motor fuel and diesel the coupon framework, see Sales Tax Treatment Re - fuel distribution. The taxpayer provided a discounted accommodations” contained in 20 nYCrr § 527.9(f) lating to the Sale and Redemption of Certain Prepaid price based on the number of points the customer is consistent with the notion that there must be con - Discount Vouchers, TSB-M-11(16)S (11/19/11), in which accrued by making purchases at a participating su - sideration to constitute receipts/rent for sales tax pur - the Department attempts to differentiate a specific- permarket. The taxpayer received the discounted poses. type of Deal of the Day voucher from other discount sales amount (and sales taxes) from the customer 13 TSB-M-11(10)S (6/29/11). vouchers and third-party discount coupons. Specifi - and was reimbursed for the discounted amount by 14 cally, the Department concluded that when a stated Id. (“When these loyalty card discounts are given Sunoco. The taxpayer did not include the credits re - face value voucher (a voucher with a specifically and the discounted item is subject to sales tax, ceived from Sunoco for purposes of sales tax receipts. stated value) is redeemed, it is generally treated in the the amount subject to sales tax generally de - The aLJ found that the Department’s analogy of the same manner as a gift card. That is, it is treated as pends on whether the discount reflects a manu - fuel discount program to a manufacturer’s coupon to cash up to the stated face value of the voucher. facturer’s discount or a store discount. If the store be “fitting.” “[B]oth the pump price received from the 21 is reimbursed for the amount of the discount by customer and the credit received from Sunoco are for a discussion of a Virginia ruling addressing a sim - the manufacturer, distributor or other third party, items of value received by petitioner for the gasoline ilar issue, see Hellerstein, State Taxation , ¶ 17.06[6][b]. it is a manufacturer’s discount. If the store re - it sells, and both are clearly encompassed within the 22 o.C.g.a. § 48-8-2(34)(a).

STaTe & LoCaL aUgUST 2015 l JoUrnaL of TaxaTIon l 83 sales price “discounts, including cash, 549 (Ga. 1967), held that “trading plement the of trad - term, or coupons that are not reim - stamps” were taxable consideration. ing stamps with cash. bursed by a third party that are al - In Colonial Stores, a grocery store re - While it is helpful to be aware of the lowed by a seller and taken by a pur - warded its customers for shopping at existing authority, the guidance related chaser on a sale.” 23 In addition, the the store by issuing “Sav-a-Stamps” to vouchers and trading stamps may Georgia statute provides that consid - with each purchase, at a rate of not be particularly relevant to mod - eration the seller receives from third 10 cents per stamp. The store occa - ern-day loyalty programs, as there are parties will be included in the tax base sionally gave away Sav-a-Stamps so many variations and differing fact

Whether or not to include redeemed loyalty rewards in the tax base for purposes of collecting tax on the sales transaction is a l complicated question.

if the seller “actually receives consid - without requiring a retail purchase. patterns. The only generalization that eration from a party other than the Collectors of the stamps could then can be drawn is that if the loyalty re - purchaser and the consideration is di - redeem the stamps for merchandise wards constitute consideration for the rectly related to a price reduction or at the store. transaction at issue, they will be in - discount on the sale.” 24 The Supreme Court of Georgia cluded in the tax base. Whether this is Therefore, in order to be treated as held that a transaction in which a the case may not be entirely clear. part of the taxable base, loyalty re - customer exchanged Sav-a-Stamps wards must constitute “consideration” for the store’s merchandise was a sale Washington for the sale, but if they are in the na - subject to the sales tax. More specifi - While Georgia’s treatment of loyalty ture of a discount or retailer’s coupon, cally, the stamps themselves repre - programs lacks certainty, Washington they would not be included. Unfor - sented “consideration” because cus - has undertaken an extensive effort to tunately, there is a dearth of authority tomers paid for the merchandise they be transparent in its taxation of loyalty in Georgia for purposes of determin - received in exchange for the stamps rewards. Washington is important be - ing whether the various types of loy - during the earlier transactions in cause it is a party to the Streamlined alty rewards would be treated as which they earned the stamps. The Sales and Use Tax Agreement, having “consideration” or would be excluded court wrote: “Thus, although the ob - adopted the uniform meaning of “sales as some type of discount or coupon. jective of the trading stamp scheme price,” 29 and because it is one of the The closest guidance in Georgia in - may have been sales promotion and few states to have issued specific guid - volves “vouchers” and “trading enticement of customers, the ance relating to loyalty programs. 30 stamps.” Georgia taxes the full retail merchandise was not given away. It The guidance came about after the De - value of an item purchased with a was paid for by the customers since partment’s Audit Division began tak - combination of cash and a voucher the cost was included in the retail sales ing the position that some retailers such as a Groupon or LivingSocial prices charged them.” 27 should have been collecting retail sales coupon. 25 Thus the Georgia Depart - Subsequent to Colonial Stores , the tax on loyalty rewards when the re - ment of Revenue treats these vouchers Georgia Department of Revenue is - wards were earned by making prior as consideration constituting part of sued a regulation stating that trans - purchases from the same retailer. The the sales price. 26 actions redeeming trading stamps are Department’s Appeals Division ini - Additionally, an old Georgia subject to the sales tax: tially sustained at least one of those Supreme Court opinion, Colonial When a trading stamp company accepts assessments, finding that because the Stores, Inc. v. Undercofler , 153 S.E.2d trade stamps or a combination of trade member earned points by becoming stamps and cash in exchange for premi - a member, providing an email address NOTES ums, the transaction is subject to the tax 23 o.C.g.a. § 48-8-2(34)(B)(i). and the trading stamp company shall and buying goods, the retailer received 24 o.C.g.a. § 48-8-2(34)(C)(i). collect the tax from the person surren - benefits and, therefore, the reward re - 25 See georgia Dep’t of rev., Georgia Section 328 Best dering the stamps, based on the total demption was for consideration and Practices Matrix (1/14/14). value of the stamp book and any cash not a discount. 26 Id. paid. The trading stamp company shall 27 Id. at 552. not pay the tax on the purchase of such The Department convened a small 28 ga. Comp. r. & regs. 560-12-2-.85(3). premiums, but should furnish its suppli - stakeholder group to discuss the issue, ers resale certificates…. 28 29 rCW 82.08.010(1)(b), (c). and the result was two forms of pub - 30 Washington excise Tax advisory 3191 (9/30/14); Wash - Notably, the regulation contem - lished guidance —an Excise Tax Advi - ington Interim Statement regarding rewards Pro - 31 grams — Commingling rewards Program awards plates both that the trading stamps sory and an Interim Statement. The (11/12/14). will have a knowable redemption Excise Tax Advisory states several im - 31 See footnote 30. value and that purchasers may sup - portant conclusions, including:

84 l JoUrnaL of TaxaTIo n l aUgUST 2015 STaTe & LoCaL • A member’s provision of his or Interestingly, the Excise Tax Advi - chaser. Therefore, it appears that sev - her name, telephone number, sory appears to take a simplistic view eral forms of third party considera - email address or physical address of third party consideration —if the tion would not constitute part of the does not represent consideration. retailer receives consideration from a sales price. For example, a lump sum • Rewards provided solely for en - third party, the reward is taxable. payment from a third party that does rollment in the program, or the However, while both the Streamlined not require that the retailer pass on a passage of time, or solely for pur - Sales and Use Tax Agreement and price reduction, or that is not fixed chasing seller’s product are ex - Washington law, provide that dis - and determinable at the time of the cluded from the selling price. counts “that are not reimbursed by a sale of the item to the purchaser, Equally important, the Excise Tax third party” are excluded from the should not constitute part of the re - Advisory excludes from qualifying “sales price”, both also go on to make tailer’s sales price. discounts: that conditioned on several require - The Interim Statement is intended • Rewards for completing surveys ments. Under both, the term “sales to address a thorny practical problem for the retailer. price” includes third party consider - for retailers, and by its nature, is sub - • Rewards received for acting as a ation only if (1) the consideration is ject to further review by the Depart - secret shopper. directly related to a price reduction ment of Revenue. Having established • Rewards received as an employee or discount, (2) the seller has an ob - in the Excise Tax Advisory that re - for making sales exceeding a cer - ligation to pass the price reduction wards received for consideration are tain target. through to the purchaser; (3) the taxable, but that certain rewards qual - • Rewards purchased for cash. amount is fixed and determinable at ify as discounts, the Interim Statement • Rewards earned from one retailer the time of the sale of the item to the addresses the problem that many re - that are redeemable at another purchaser, and (4) (i) the purchaser tailers do not trace how specific re - retailer, and when the first retailer presents documentation to the seller wards are earned. Consequently, they reimburses the second. when such documentation is author - have commingled (taxable and non- • Rewards received for purchases us - ized, distributed, or granted by a third taxable without the ability to differen - ing a co-branded credit card when party with the understanding that the tiate) rewards. As a generality, the De - the bank reimburses the retailer. third party will reimburse; (ii) the partment’s position is that in the • Rewards for purchases at one re - purchaser identifies him or herself as absence of the ability to trace the re - tailer, under a program adminis - a member of a group entitled to a wards, they will all be taxable. Alter - tered by a separate company, price reduction; or (iii) the price re - natively, the Department has offered when the separate company re - duction is identified as a third party a “prepayment option” whereby a re - imburses the retailer. price reduction on the invoice re - tailer may prepay sales tax on taxable Thus, such rewards would be con - ceived by the purchaser, or on the rewards at the time they are issued if sidered taxable consideration. documentation presented by the pur - they will be commingled with dis -

DuCharme ad 1/3 pg, 4 color

STaTe & LoCaL aUgUST 2015 l JoUrnaL of TaxaTIon l 85 count rewards. While the Depart - of loyalty programs, and a ruling re - the business side is often reinventing, ment’s purpose for offering this pre - lated to the taxation of one program modifying, and updating a company’s payment option is well intended, it is may not necessarily be relevant to loyalty programs as well as develop - yet to be seen whether retailers can how the redemption of loyalty re - ing new and different loyalty pro - and will report using this prepayment wards pursuant to another program grams. Modifications to an existing option. So far, it appears that retailers should be treated. program can affect the tax treatment may have as much trouble complying What is entirely clear is that the of the program, and any new pro - with the prepayment option as trying states differ in their approaches. Thus, grams’ tax treatment may not be the to trace how rewards are earned. there is no “one size fits all” answer same as the prior program. Finally, neither form of guidance for taxpayers. This can leave taxpayers Finally, taxpayers should consider addresses a potential use tax issue. An open to certain risks. For example, a whether to implement a compliance early unpublished draft of the Excise company providing a loyalty pro - system that can track applicable data Tax Advisory provided that if a re - gram may determine that it will not for purposes of the positions the com - ward constituted a bona fide discount, collect any tax when loyalty rewards pany determines to take in each state, but the redemption reduces the sales are redeemed on the basis that the re - including tracking the rewards and price to zero, the retailer would owe demption of the rewards operates how they are earned and redeemed. use tax on the product provided at akin to a retailer’s coupon and is not As evidenced by the ongoing discus - no charge. This result may be consis - taxable. This may very well be the sions in Washington, this type of gran - tent with the recent case of Sprint case in a number of states. However, ular ability could shape whether Spectrum, LP v. State, Dept. of Rev - by taking a blanket approach across something is taxable. enue , 174 Wash. App. 645, 302 P.2d all states, this company risks being au - As this article highlights, whether 1280 (Wash. App. Div., 2013) , rev. de - dited and assessed by states that do or not to include redeemed loyalty nied 178 Wn.2d 1024 (2013). During not agree with its characterization. At rewards in the tax base for purposes the stakeholder process, attempts were the other end of the spectrum, a com - of collecting tax on the sales transac - made to analogize loyalty programs pany that does not want to face the tion is a complicated question. The with two-for-one arrangements. The risk of audit could take the global po - starting point for analysis should be Department agrees that two-for-one sition that loyalty rewards constitute the state’s definition of the base upon purchases are not subject to addi - consideration when redeemed and which the tax is imposed (i.e. sales tional sales tax (sales tax is simply collect tax on the full amount of the price). While some states have further owed on the cash consideration paid), sale. In this situation, it is possible that authority that provides direct guid - and furthermore, there is no use tax a company may be over-collecting in ance for today’s loyalty programs, the because the retailer has made a sale certain states and thus opening itself specific guidance in many other states for consideration. However, the De - up to the risk of a class action lawsuit. is restricted due to the factual basis partment distinguishes loyalty pro - of a particular case or ruling. In other grams and two-for-one arrangements states, the relevant authority is ane - because of the passage of time be - WHAT SHOULD mic at best. Nonetheless, taxpayers tween the purchases in which the re - TAXPAYERS DO? should understand the states’ posi - ward is earned and the redemption. Given the complexities and uncer - tions to the extent possible, knowing Therefore, the use tax issue arises for tainty in this area, a company’s tax that the answers will not be uniform the retailer with a loyalty program but department should make every effort across state lines. The determination not a two-for-one arrangement. It is to understand the specifics of the as to taxability will also depend in unclear what the absence of this dis - company’s loyalty program. It can large part on the specifics of each loy - cussion in the final Excise Tax Advi - then examine the states in which the alty program, so it is important to sory means, but retailers should be company has the most loyalty reward have a working understanding of the aware of this potential use tax issue. redemptions and determine the best company’s loyalty program, includ - course of action in each state. It may ing how rewards are earned and re - be advisable to seek a ruling from the deemed, as well as any changes or RISKS FACING TAXPAYERS revenue department in a state where variations that are made in the pro - As the above discussion of three states the guidance is unclear and the po - gram that could affect the taxation illustrates, determining the tax treat - tential liability could be significant. It analysis. Taxpayers are well advised ment of loyalty programs is quite is also vitally important for tax de - to consider their reward programs complex and the analysis may often partments to be in constant commu - proactively given the increasing focus result in uncertainty. This is true par - nication with the business side of the such programs get both in the tax ticularly because there are many types program. In the authors’ experience, and business context. l

86 l JoUrnaL of TaxaTIo n l aUgUST 2015 STaTe & LoCaL