REASONS FOR JUDGMENT
Hogan J.
I.
INTRODUCTION
[1] President’s Choice Bank (“PC Bank”) appeals reassessments made by the Minister of National Revenue (the “Minister”) pursuant to the Excise Tax Act (the “Act”). There are two appeals.
[2] The first appeal concerns the Notice of Reassessment dated March 26, 2014, which reassessed PC Bank’s net tax for the annual reporting period commencing December 31, 2008 and ending December 30, 2009 (the “2009 Appeal”). The second appeal concerns the Notice of Reassessment dated June 23, 2015, which reassessed PC Bank’s net tax for the annual reporting periods ending December 30, 2010, December 30, 2011 and December 30, 2012 (the “2010—2012 Appeal”). There are three main issues addressed in the 2009 Appeal and the 2010—2012 Appeal (collectively, the “PC Bank Appeals”).
[3] The first issue is whether PC Bank’s supply to the Canadian Imperial Bank of Commerce (“CIBC”) is an exempt “financial service” or a taxable supply (the “PCF Supply Issue”). The PCF Supply Issue is common to the PC Bank Appeals. This issue is also raised in the appeal of Canadian Imperial Bank of Commerce v Her Majesty the Queen (the “CIBC Appeal”), which I released concurrently with this Judgment. The parties to the PC Bank Appeals and the CIBC Appeal agreed that the evidence in the CIBC Appeal be treated as evidence in relation to the PCF Supply Issue in the PC Bank Appeals. Therefore, the PC Bank Appeals in respect of that issue are dismissed in accordance with the CIBC Appeal, which I have attached as Appendix I.
[4] The second issue in the PC Bank Appeals is whether PC Bank is entitled to claim notional input tax credits (“NITCs”) pursuant to subsection 181(5) for payments it made to Loblaws Inc. (“Loblaws”) when clients redeemed loyalty points at Loblaws stores (the “NITC Issue”). The parties agree that the NITC Issue turns on whether or not PC Bank pays the redemption amounts to Loblaws in the course of a “commercial activity” as defined in subsection 123(1).
[5] The third issue in the PC Bank Appeals is whether the services provided by Total Systems Services Inc. (“TSYS”) and First Data Resources Inc. (“FDR”) to PC Bank for use in PC Bank’s credit card business are exempt supplies (the “FDR/TSYS Issue”).
[6] The material facts are set out below, followed by the analysis of the NITC Issue and the FDR/TSYS Issue.
II.
MATERIAL FACTS
[7] The parties filed a partial agreed statement of facts (“PASF”). I have reproduced the relevant parts below for ease of reference:
President’s Choice Bank (“PC Bank”)
1. PC Bank is a Schedule I bank pursuant to the Bank Act, S.C. 1991, c. 46 that is, and was at all material times, resident in Canada and registered under Part IX of the Excise Tax Act, R.S.C. 1985, c. E‑15, as amended (the “Act”) for purposes of the goods and services tax (“GST”) and the harmonized sales tax (“HST”).
2. PC Bank is, and was at all material times, a listed financial institution for purposes of the Act. Effective December 31, 2009, PC Bank was a selected listed financial institution for purposes of the Act.
3. PC Bank is a wholly-owned subsidiary of Loblaw Financial Holdings Inc. and an indirect wholly-owned subsidiary of Loblaws Inc. (“Loblaws”). Loblaws is a wholly-owned subsidiary of Loblaw Companies Limited (“LCL”).
PC Bank MasterCards
4. MasterCard International Incorporated operates the MasterCard Worldwide Network, which processes payment transactions made under its payment brands, including MasterCard credit cards. A typical MasterCard transaction is described in Appendix “A” to this Partial Agreed Statement of Facts.
5. Since 2011, PC Bank has been a licensee of MasterCard and an issuer of President’s Choice branded MasterCard credit cards (“PC MasterCards” or in the singular a “PC MasterCard”) to its customers (the “Cardholders”).
6. Cardholders may use their PC MasterCards to make purchases at merchants that accept MasterCard-branded credit cards and to obtain cash advances.
The Points Program
7. Prior to March 1, 2008, PC Bank owned and operated a loyalty points program (the “Points Program”) which provided for the rewards of loyalty points (“PC Points”).
8. Effective March 1, 2008, PC Bank transferred the Points Program to President’s Choice Services Inc. (formerly President’s Choice Financial Inc.) (“PCSI”), an indirect subsidiary of Loblaws. To effect the transfer, PC Bank and PCSI entered into a Transfer Agreement, General Conveyance agreement, and Assignment Agreement each dated March 1, 2008. The Transfer Agreement was amended on July 31, 2008.
9. PC Bank and PCSI entered into a Loyalty Services Agreement (the “Services Agreement”) made effective March 1, 2008 and a Licence Agreement (“Licence Agreement”) dated July 31, 2008.
10. PC Bank, PCSI, and Loblaws entered into a Loyalty Expense Agreement (the “Expense Agreement”) made effective March 1, 2008.
11. The Licence Agreement, Services Agreement, and Expense Agreement were the subject of a rectification order granted by the Ontario Superior Court of Justice on August 16, 2016 (the “Rectification Order”).
12. Pursuant to the Rectification Order, the Licence Agreement, Services Agreement, and Expense Agreement were rectified nunc pro tunc in the form attached to the Order.
Cardholders as members of the Points Program
13. All Cardholders are automatically members of the Points Program. PC Bank issues PC Points to Cardholders whenever they use their PC MasterCard (points issued by PC Bank referred to herein as “PCB Points”).
14. All members of the Points Program are subject to the terms and conditions of the Points Program.
15. At all material times, for purchases made on the PC MasterCard, Cardholders automatically earned:
a. 20 PCB Points for every $1 spent using their PC MasterCard at a Loblaw‑banner store where President’s Choice products are sold; and
b. 10 PCB Points for every $1 spent using their PC MasterCard anywhere else.
Issuance and Redemption of PC Points
16. Pursuant to the Licence Agreement (as rectified), amongst other things:
a. PCSI granted, for the duration of the term as set out therein, a non-exclusive, royalty-free license to PC Bank the right to issue PC Points to members of the PC Points loyalty program (as defined therein) who are PC Bank’s customers subject to the terms and conditions of the Licence Agreement and the Loyalty Terms and Conditions; and
b. PC Bank acknowledged that, by virtue of being a Licensee, it will be liable for the redemption for all PCB Points.
17. PC Points were redeemable at certain supermarkets within Canada owned or controlled by Loblaws or a subsidiary, or that were operated by Loblaws franchises under a trademark owned or controlled by Loblaws, and any other locations as may be agreed to by Loblaws or PCSI, as applicable, or against any reward that may be offered as part of the Loyalty Program from time to time.
18. Pursuant to the Expense Agreement (as rectified), amongst other things:
a. for every $1.00 of purchases made by Cardholders using their PC MasterCard at Loblaw Stores where PC Bank issues PCB Points to the Cardholder, Loblaws will pay $0.0075 to PC Bank;
b. for every $1.00 of notional value of PCB Points accumulated by a Cardholder using a PC MasterCard and redeemed by such Cardholder, Loblaws will pay $0.35 to PC Bank; and
c. for every $1.00 of notional value of PCB Points accumulated by a Cardholder using a PC MasterCard and redeemed by such Cardholder, PC Bank will reimburse/pay Loblaw Inc. $1.00 (the “Redemption Payment”).
First Data Resources LLC (“FDR”)
19. At all material times, FDR was a corporation not resident in Canada and not registered under Part IX of the Act for GST/HST purposes.
20. PC Bank and FDR entered into a Service Agreement dated January 31, 2001 (the “FDR Agreement”), pursuant to which FDR made a single compound supply to PC Bank (the “FDR Supply”).
21. The FDR Agreement was amended on January 1, 2002 (the “First FDR Amendment”) and March 1, 2003 (the “Second FDR Amendment”).
22. Pursuant to the FDR Agreement and FDR Amendments, PC Bank paid FDR for the FDR Supply. FDR invoiced PC Bank for the FDR Supply. A sample invoice from FDR is available.
23. FDR did not collect GST/HST in respect of the FDR Supply pursuant to the FDR Agreement. In its annual reporting period ending December 30, 2009, PC Bank did not self-assess GST/HST on the consideration paid to FDR pursuant to Division IV of the Act.
Total Systems Services, Inc. (“TSYS”)
24. TSYS is a global payment solutions provider that provides services to financial and nonfinancial institutions.
25. At all material times, TSYS was a corporation not resident in Canada and not registered under Part IX of the Act for GST/HST purposes.
26. PC Bank and TSYS entered into a Processing Services Agreement dated December 10, 2009 (the “TSYS Agreement”).
27. Pursuant to the TSYS Agreement, TSYS provided a single compound supply to PC Bank (the “TSYS Supply”). PC Bank paid TSYS for the TSYS Supply. A sample invoice from TSYS is available.
28. PC Bank self‑assessed and remitted GST/HST in respect of the TSYS Supply totaling $267,866, $703,411, and $934,234 in its annual reporting periods ending December 30, 2010, December 30, 2011, and December 30, 2012, respectively. PC Bank claimed and was allowed input tax credits of $4,840, $14,730, and $19,574 in its annual reporting periods ending December 30, 2010, December 30, 2011, and December 30, 2012, respectively.
Financial Statements
29. KPMG LLP prepared an Auditors’ Report to the Shareholder in respect of PC Bank as at December 31, 2009 and 2008, dated January 28, 2010, as at December 31, 2010 and 2009, dated February 22, 2011, and as at December 31, 2011 dated April 3, 2012 (the “Financial Statements”).
The December 31, 2008 to December 14, 2009 Period
30. PC Bank charged, collected, and remitted GST/HST on the CIBC Payments, as defined below, inter alia, by way of an invoice dated August 27, 2007 in respect of the 2003 to 2006 periods.
Assessments Under Appeal
2009 Period
31. On February 19, 2010, PC Bank filed a GST return for the annual reporting period ending December 30, 2009 (the “2009 Period”), which, amongst other things:
a. did not claim any operational input tax credits (“ITCs”) pursuant to subsection 169(1) of the Act;
b. did not claim any notional ITCs pursuant to subsection 181(5) of the Act;
c. did not include any self‑assessed GST/HST collectible on the consideration paid for the FDR Services pursuant to Division IV of the Act; and
d. did not include any self‑assessed GST/HST collectible on the consideration paid for supplies from MCII, a non-resident, pursuant to Division IV of the Act.
32. By way of a Notice of (Re)Assessment dated March 26, 2014 (the “2009 Reassessment”), the Minister of National Revenue (the “Minister”) reassessed PC Bank’s net tax, including an increase to tax payable under Division IV of the Act, for the annual reporting period commencing December 31, 2008 and ending December 30, 2009 (the “2009 Period”). The 2009 Reassessment, amongst other things:
a. assessed PC Bank for tax payable under Division IV of the Act pursuant to paragraph 296(1)(b) of the Act on the consideration paid for the FDR Services;
b. assessed PC Bank for tax payable under Division IV of the Act pursuant to paragraph 296(1)(b) of the Act on the consideration paid for the MasterCard Services; and
c. increased PC Bank’s GST/HST collectible on the consideration paid for supplies made by PC Bank to the CIBC (the “CIBC Payments”).
33. PC Bank filed a Notice of Objection dated June 23, 2014 to a portion of the 2009 Reassessment. The Notice of Objection raised, amongst other things, whether:
a. the CIBC Payments were in respect of taxable or exempt supplies;
b. the Minister properly assessed Division IV tax on the consideration paid for the services provided by MCII (the “MCII Service”);
c. the Minister properly assessed Division IV tax on the consideration paid for the FDR Supply; and
d. PC Bank is entitled to additional ITCs pursuant to subsection 296(2) of the Act.
34. Subsequent to the commencement of the audit, PC Bank claimed operational ITCs totaling $88,674.09 and notional ITCs totaling $1,583,615.65.
35. PC Bank filed an appeal to the Tax Court of Canada in respect of the 2009 Reassessment on October 4, 2017, being court file no. 2017-3925(GST)G (the “2009 Appeal”).
2010—2012 Periods
36. On June 24, 2013, PC Bank filed its Selected Listed Financial Institution GST/HST returns for the annual reporting periods ending December 30, 2010 (the “2010 Period”), December 30, 2011 (the “2011 Period”), and December 30, 2012 (the “2012 Period”) (and collectively, the “2010—2012 Periods”). The returns for the 2010-2012 Periods, amongst other things:
a. reported GST/HST collectible on a portion of the CIBC Payments;
b. claimed ITCs regarding the CIBC Payments;
c. did not claim any notional ITCs pursuant to subsection 181(5) of the Act;
d. self‑assessed GST/HST pursuant to Division IV of the Act in the amounts of $267,866, $703,411, and $934,234, respectively, in respect of the TSYS Supply; and
e. did not include any self-assessed GST/HST collectible on the consideration paid for supplies from MCII, a non-resident, pursuant to Division IV of the Act (the above defined MCII Service).
37. On June 30, 2014, PC Bank filed amended returns for the 2010-2012 Periods reporting notional ITCs of $2,496,144, $3,220,667, and $3,503,561, respectively.
38. By way of Notices of (Re)Assessment dated June 23, 2015 (the “2010—2012 Reassessments”), the Minister reassessed PC Bank’s net tax, including an increase to tax payable under Division IV of the Act, for the 2010—2012 Periods. The 2010—2012 Reassessments, amongst other things:
a. increased PC Bank’s GST/HST collectible on the CIBC Payments;
b. allowed notional ITCs of $45,101, $67,445, and $73,405, respectively; and
c. assessed PC Bank for tax payable under Division IV of the Act pursuant to paragraph 296(1)(b) of the Act on the consideration paid for the MCII Service.
39. PC Bank filed Notices of Objection dated September 18, 2015 to a portion of the 2010‑2012 Reassessments. The Notices of Objection raised, amongst other things, whether:
a. the CIBC Payments were in respect of taxable or exempt supplies;
b. the Minister properly assessed Division IV tax on the consideration paid for the MCII Service;
c. PC Bank is entitled to additional notional ITCs;
d. PC Bank is entitled to a refund of tax self‑assessed in respect of the TSYS Supply on the basis that it was assessed in error;
e. PC Bank is entitled to a rebate for tax paid in error to PCSI in the 2011 Period only.
40. PC Bank filed an appeal to the Tax Court of Canada in respect of the 2010—2012 Reassessments on October 3, 2017, being court file no. 2017- 3931(GST)G (the “2010—2012 Appeal”).
[8] The defined terms used hereinafter have the meaning assigned to them in the PASF unless otherwise provided.
III.
THE NITC ISSUE
[9] The parties agree that the NITC Issue centres on whether the Redemption Payment was made by PC Bank “in the course of a commercial activity” pursuant to subsection 181(5). If PC Bank made the Redemption Payment in the course of an exempt “financial service”, then the Redemption Payment could not have been made “in the course of a commercial activity” because the “commercial activity” definition specifically excludes exempt supplies. PC Bank is only entitled to claim an NITC pursuant to subsection 181(5) if the Redemption Payment was made in the course of a “commercial activity” of PC Bank.
A.
Position of the Parties: The NITC Issue
[10] PC Bank’s position is that it made the Redemption Payments in the course of its operation of the Loyalty Program, which it states is a commercial activity. According to PC Bank, the three payments set out in the Expense Agreement (as rectified) are all related to its operation of the Loyalty Program. Therefore, PC Bank paid the Redemption Payment in the course of a commercial activity and is entitled to claim NITCs under subsection 181(5). For PC Bank, there is no basis to conclude that the Redemption Payment was made in the course of a different activity (i.e. the PC Bank MasterCard business). PC Bank acknowledges that the PC Bank MasterCard activities on their own are exempt in nature.
[11] The Respondent’s position is that PC Bank issued PCB Points to Cardholders to entice them to acquire and then use their PC MasterCards. PC Bank was required to reimburse Loblaws by means of the Redemption Payment when PC Bank customers redeemed the PCB Points in the Loblaws‑affiliated stores. According to the Respondent, in this context, the Redemption Payments were made by PC Bank to Loblaws in the course of making exempt supplies of a “financial service” to Cardholders. Since a financial services business is excluded from the definition of a “commercial activity” in subsection 123(1), PC Bank is not entitled to claim NITCs for the redemption price paid in relation to the PCB Points under subsection 181(5).
B.
Legislation
[12] Subsection 165(1) provides that GST is payable by recipients of taxable supplies:
165 (1) Imposition of goods and services tax—Subject to this Part, every recipient of a taxable supply made in Canada shall pay to Her Majesty in right of Canada tax in respect of the supply calculated at the rate of 5% on the value of the consideration for the supply.
[13] Section 181 sets out special rules for the treatment of coupons redeemed on purchases. The relevant parts of section 181 read as follows:
181 (1) Definitions – The definitions in this subsection apply in this section.
“coupon” includes a voucher, receipt, ticket or other device but does not include a gift certificate or a barter unit (within the meaning of section 181.3).
“tax fraction” of a coupon value or of the discount or exchange value of a coupon means
(a) where the coupon is accepted in full or partial consideration for a supply made in a participating province, the fraction
A/B
where
A is the total of the rate set out in subsection 165(1) and the tax rate for that participating province, and
B is the total of 100% and the percentage determined for A; and
(b) in any other case, the fraction
C/D
where
C is the rate set out in subsection 165(1), and
D is the total of 100% and the percentage determined for C.
(2) Acceptance of reimbursable coupon – For the purposes of this Part, other than subsection 223(1), where at any time a registrant accepts, in full or partial consideration for a taxable supply of property or a service (other than a zero‑rated supply), a coupon that entitles the recipient of the supply to a reduction of the price of the property or service equal to a fixed dollar amount specified in the coupon (in this subsection referred to as the “coupon value”) and the registrant can reasonably expect to be paid an amount for the redemption of the coupon by another person, the following rules apply:
(a) the tax collectible by the registrant in respect of the supply shall be deemed to be the tax that would be collectible if the coupon were not accepted;
(b) the registrant shall be deemed to have collected, at that time, a portion of the tax collectible equal to the tax fraction of the coupon value; and
(c) the tax payable by the recipient in respect of the supply shall be deemed to be the amount determined by the formula
A–B
where
A is the tax collectible by the registrant in respect of the supply, and B is the tax fraction of the coupon value.
…
(5) Redemption of coupon – For the purposes of this Part, where, in full or partial consideration for a taxable supply of property or a service, a supplier who is a registrant accepts a coupon that may be exchanged for the property or service or that entitles the recipient of the supply to a reduction of, or a discount on, the price of the property or service and a particular person at any time pays, in the course of a commercial activity of the particular person, an amount to the supplier for the redemption of the coupon, the following rules apply:
(a) the amount shall be deemed not to be consideration for a supply;
(b) the payment and receipt of the amount shall be deemed not to be a financial service; and
(c) if the supply is not a zero‑rated supply and the coupon entitled the recipient to a reduction of the price of the property or service equal to a fixed dollar amount specified in the coupon (in this paragraph referred to as the “coupon value”), the particular person, if a registrant (other than a registrant who is a prescribed registrant for the purposes of subsection 188(5)) at that time, may claim an input tax credit for the reporting period of the particular person that includes that time equal to the tax fraction of the coupon value, unless all or part of that coupon value is an amount of an adjustment, refund or credit to which subsection 232(3) applies.
[14] Subsection 181(2) applies to “coupons” that entitle the recipient of the supply to a reduction of the price of the property or service for a fixed dollar amount (“Fixed Value Coupon”). Under subsection 181(2), a Fixed Value Coupon redeemed by a customer in a store is treated like cash. This means that the GST/HST is not reduced on the purchase price.
[15] For subsection 181(2) to apply, certain conditions must be met. First, there must be a “registrant”. A “registrant” is defined in subsection 123(1) as a person who is GST‑registered (e.g. a retailer). Second, the registrant must accept the “coupon”. A “coupon”, which is defined in subsection 181(1), includes “a voucher, receipt, ticket or other device but does not include a gift certificate or a barter unit … .” Third, this “coupon” must be accepted in full or partial consideration for a taxable supply of “property” or “a service”. Fourth, the supply cannot be a “zero‑rated supply”. A “zero‑rated supply” is defined in subsection 123(1) as a supply included in Schedule VI. Fifth, there must be a “recipient” of the supply. A “recipient” of a supply of property or a service is defined in subsection 123(1) to mean a person. Generally, a “recipient” of a supply means a person contractually obligated to pay for the supply, such as a customer. Sixth, the “coupon” is a Fixed Value Coupon. Lastly, the “registrant” can reasonably expect to be paid an amount for the redemption of the Fixed Value Coupon by another person.
[16] If the conditions in subsection 181(2) are met, the deeming rules under that provision apply. Paragraph 181(2)(a) provides that the tax applies as if the coupon was not accepted. This means that GST/HST is added to the purchase price before the amount of the Fixed Value Coupon is deducted. Paragraph 181(2)(b) provides that the registrant is deemed to have collected a portion of the tax equal to the tax fraction of the value of the Fixed Value Coupon. Paragraph 181(2)(c) provides that the tax payable by the recipient (e.g. customer) in respect of the supply is deemed to be (1) the amount of the tax collectible by the registrant (e.g. retailer) in respect of the supply less (2) the “tax fraction” of the coupon value. Subsection 181(1) defines a “tax fraction”.
[17] To illustrate the operation of subsection 181(2), the Respondent provided the following useful example:
38. Consider, for example, a customer who uses a reimbursable coupon for $1.00 off of a $10 bottle of shampoo, before HST of 15%, at a retailer:
| Price of the shampoo
|
$10.00
|
| HST at 15%
|
$1.50
|
| Subtotal
|
$11.50
|
| Less coupon
|
(1.00)
|
| |
|
39. In this example, the registrant (retailer) is deemed to have collected HST of $1.50 pursuant to subsection 181(2). It must report and remit $1.50 of HST.
40. Pursuant to paragraph 181(2)(c), however, the recipient (customer) cannot claim an ITC of $1.50. The recipient’s tax payable is deemed to be the tax collectible by the registrant (in this case, $1.50) less the tax fraction of the coupon value (in this case, $1.00/1.15 = $0.13). Therefore, the recipient may claim an ITC, if the purchase satisfies subsection 169(1) of the Act, in the amount of $1.37.
[18] Subsection 181(5) entitles a particular person to an NITC for the tax fraction equal to the coupon value if certain conditions are met. First, a registrant (e.g. a retailer) must accept as full or partial consideration for a taxable supply of property or a service a “coupon” from a recipient (e.g. a customer). This coupon may either be exchanged for property or a service or entitles the recipient to a reduction of the price of the property or service. Second, a particular person (e.g. a manufacturer) pays an amount to the supplier (e.g. a retailer) for the redemption of the “coupon”. Third, this redemption payment is made in the course of a “commercial activity” of a particular person (e.g. the manufacturer). A “commercial activity” is defined in subsection 123(1). Unlike subsection 181(2), subsection 181(5) may apply to “zero‑rated supplies”.
[19] If the conditions in subsection 181(5) are met, the deeming rules under that provision apply. Paragraph 181(5)(a) provides that the redemption payment is deemed not to be consideration for a supply. Paragraph 181(5)(b) provides that the payment and receipt of the redemption payment shall be deemed not to be a financial service. Paragraph 181(5)(c) provides that the particular person (e.g. a manufacturer), who is a registrant, may claim an NITC equal to the tax fraction of the value of the Fixed Value Coupon. This paragraph only applies if the supply is not zero‑rated and the coupon entitled the recipient (e.g. a customer) to a reduction of the price of the property or service equal to the value of the Fixed Value Coupon.
[20] As noted, one of the conditions that must be met for subsection 181(5) to apply is that the redemption payment made by the particular person to the supplier must be made “in the course of a commercial activity” of that particular person. The term of “commercial activity” is defined under subsection 123(1) as follows:
123(1) Definitions
…
“commercial activity” of a person means
(a) a business carried on by the person (other than a business carried on without a reasonable expectation of profit by an individual, a personal trust or a partnership, all of the members of which are individuals), except to the extent to which the business involves the making of exempt supplies by the person.
…
“exempt supply” means a supply included in Schedule V.
[Emphasis added.]
[21] An “exempt supply” is defined in Part VII of Schedule V to include:
1. A supply of a financial service . . . .
[22] A “financial service” is defined in subsection 123(1). Thus, the making of an “exempt supply” of a “financial service” does not constitute a “commercial activity” and does not fall within the definition of a “taxable supply” for which NITCs would be available.
C.
Review of the Case Law
[23] To understand NITCs, one must begin with subsection 169(1). Generally, input tax credits under subsection 169(1) are available for GST paid in relation to the acquisition of property or services by a person to the extent that such property or services are acquired for consumption or use in the course of commercial activities of that person. In City of Calgary v Canada, the Supreme Court of Canada described the basic structure of the GST regime as follows:
[16] … The GST is designed to be a tax on consumption, and as such, the ETA contemplates three classes of goods and services: (1) taxable supplies; (2) exempt supplies; and (3) zero‑rated supplies. Taxable supplies currently attract a goods and services tax of 5% (7% at the relevant time) each time they are sold. To the extent that the purchaser of a taxable supply uses that good or service in the production of other taxable supplies, that is, in the course of commercial activities, the purchaser is entitled to an ITC and can recover the tax it has paid from the government. This is to prevent the cascading of GST, and to allow the obligation to pay GST to flow through to the ultimate consumer. The other two classes of goods and services, exempt supplies and zero‑rated supplies, do not attract GST from the ultimate consumer. Vendors of exempt supplies, while paying the GST on their purchases, are not entitled to ITCs. In consequence, GST is paid to the federal government at the penultimate stage in the production chain rather than by the ultimate consumer.
[24] There is limited case law on subsection 181(5). President’s Choice Bank v R (the “2009 Decision”) is the main case that addresses subsection 181(5) and whether or not in the context of that provision, an input was made “in the course of a commercial activity”. In that case, one of the issues before this Court was whether PC Bank was entitled to NITCs pursuant to subsections 181(2) and 181(5) in respect of reimbursements made by PC Bank to Loblaw on the redemption of PC Points during the 2001 and 2002 taxation periods. In addressing that issue, Lamarre J., as she then was, determined that in the context of subsection 181(5), “[i]t is at the time of redemption of the coupon that we have to determine whether that coupon has a fixed dollar value.”
[25] Although Lamarre J found that the coupons had a fixed dollar value at the time of redemption, she held that PC Bank was not entitled to NITCs on PC Points awarded on President’s Choice Financial products and subsequently redeemed. This conclusion was based on the finding that the supply of the PC Points in accordance with the agreement in effect at that time, was part of the exempt supplies—financial services—offered by PC Bank through CIBC. These supplies were not subject to GST. Because financial services are exempt supplies, PC Bank did not make them in the course of a commercial activity. However, Lamarre J. stated that for PC Points awarded on taxable supplies, PC Bank would be entitled to NITCs when it pays for the redemption of those points.
[26] In Nestlé Canada Inc. v R, the Tax Court made some observations in respect of subsections 181(2) and (5). The main issue in that case was whether instant rebate coupons (“IRCs”) issued by the taxpayer, Nestlé Canada Inc. (“Nestlé”), fit within the requirements for a coupon set out in section 181 or whether the IRCs should be characterized as promotional allowances. If the IRCs qualified as coupons pursuant to subsection 181, “Nestlé would be entitled to its ITCs for any excess GST/HST paid by the consumer when that consumer purchased a Nestlé product at Costco [Wholesale Canada Ltd.].” In addressing whether the IRCs qualified as coupons, Lamarre J. made the following observations on the operation of subsections 181(2) and (5):
[38] Under subsection 181(2), Costco is required to collect GST/HST on the pre‑discount price of the Nestlé products.
[39] Subsection 181(2) thus requires the customer to overpay GST/HST on the Nestlé products and then deems the customer to have paid only the GST/HST attributable to the post‑discount price. The reason for implementing this practice was explained by counsel for the Respondent in his oral submissions, in which he referred the Court to the policy underlying the treatment of discount coupons. The object of the practice was to simplify the treatment of coupons for small grocers, who, in the 1990s, did not have easy access to cash registers that, for the purpose of the application of the GST/HST, could distinguish between coupons for taxable supplies and coupons for non‑taxable (or zero‑rated) supplies.
[40] This excess GST/HST does not go to the government however. Instead, subsection 181(5) allows the provider of the coupon, here Nestlé, to obtain an input tax credit for the excess GST/HST paid by the Costco customer.
[41] The benefit represented by this additional input tax credit, received at the customer’s expense, is why Nestlé is claiming that its transactions fit within the section 181 coupon regime, instead of the section 232.1 promotional allowance regime.
[27] No further analysis was provided in respect of subsection 181(2) or (5) because Lamarre J. concluded that the IRCs were not coupons pursuant to section 181.
[28] Neither the 2009 Decision nor Nestlé Canada provides significant guidance for the NITC Issue in this appeal. In the context of other provisions of the Act, including subsection 169(1), the courts have considered on a number of occasions whether an input was made “in the course of” a “commercial activity”. The meaning of these phrases as described by the courts is outlined below.
(i)
The phrase “in the course of” has a wide meaning.
[29] The phrase “in the course of” has a wide meaning. Courts have concluded that an ITC is available if an item directly or indirectly contributes to the production of articles or the provision of services that are taxable. For example, in Midland Hutterian Brethren v R, at issue was whether the applicant could claim an ITC in respect of the cost of certain cloth purchased to make work clothing for use by its members in its commercial activity—farming operations. The Federal Court of Appeal found that the cloth contributed to the applicant’s commercial activities and bottom line. In arriving at this conclusion, the Federal Court of Appeal noted:
[23] … This Court has already interpreted these words to mean that, when a registrant incurs a GST expense in connection with its commercial activities, it is entitled to an ITC. As Stone J.A. explained in Metropolitan Toronto Hockey League decision:
The scheme of the Act allows a business to claim refund or credit of any tax paid on the purchase or services connected to its sale of taxable supplies. In this way the tax is ultimately paid only by the final non commercial purchaser of a taxable supply [emphasis added].
[24] When the phrase “connected to” was used by Justice Stone to explain the words in the statute, the meaning it conveyed was that the supplies must contribute to the production of articles or the provision of services that are taxable. It would not be enough to qualify as being connected to the business activity if something, like a cigarette, were merely consumed while engaged in the business activity, for that would not contribute to the commercial activity that will ultimately produce taxable supplies.
[25] There is no language in subsection 169(1) that requires the use in question to be exclusively commercial or that distinguishes between property acquired and used directly and property acquired and altered before its use in commercial activities. Once an item is found to be acquired and used in connection with the commercial activities of a GST registrant and that item directly or indirectly contributes to the production of articles or the provision of services that are taxable, then an ITC is available using the formula in that subsection. Any possible abuse is to be combatted by requiring evidence of intended use and an adjustment in the percentage of ITC allowed by the Minister.
[Emphasis added.]
[30] Courts have found that there must be a “sufficient nexus or connection” between the input and the commercial activity. For example, in General Motors of Canada Ltd. v R, the Federal Court of Appeal upheld this Court’s conclusion that there was a “sufficient nexus or connection” between services provided by investment managers and the commercial activities of General Motors of Canada Ltd. (“GMCL”). In that decision, the Federal Court of Appeal noted that:
[44] The Tax Court Judge gave to the words “in the course of”, found in paragraph 169(1)(c), a wide meaning given by this Court in The Queen v. Blanchard, 95 D.T.C. 5479 (F.C.A.) and in M.N.R. v. Yonge Eglington Building Ltd., 74 D.T.C. 6180, at page 6184, where the words “in connection with”, or “incidental to”, or “arising from” were suggested. She held that GMCL’s responsibilities to properly manage the Pension Plan assets were derived not only through the agreements but also through its duties as administrator under the OPBA and its duties to provide pension benefits to its employees (her para. 65). She noted that pension benefits, like salaries, are part of the compensation package which is an integral component to the commercial activities of the corporation. She fully explains these considerations at paragraphs 66‑67. At paragraph 67 she stated:
… The only logical, common sense conclusion is that all of the functions of GMCL, in relation to these pension assets, are for the sole benefit of its employees, both the salaried and hourly employees and, consequently, they are an essential component to GMCL’s business activities. Therefore, GMCL acquired the services of the Investment Managers for use in its commercial activities. As such, while GMCL does not directly utilize the services in making GST supplies in its operations, those services are part of its inputs toward its employee compensation program, which is a necessary adjunct of its infrastructure to making taxable sales. The expenses are not personal in nature. They are ancillary to the primary business activities of GMCL and meet the need of attracting and maintaining an adequate employee base to support its primary business operations. Therefore these expenses, although indirect expenses to GMCL’s business, qualify as expenses paid for in the consumption or use in the course of the commercial activities of GMCL. Subsection 169(1) does not require that managing a pension plan be the sole commercial activity of a person, only that the supply be consumed or used “in the course of commercial activities”. To divorce the services of the Investment Managers from the commercial activities of GMCL, in the manner that the Respondent would have me do, ignores not only the contractual and statutory obligations of GMCL but also the commercial realities of a competitive marketplace.
[Emphasis in original.]
[31] At issue in General Motors, was whether GMCL was eligible for ITCs under subsection 169(1) of the Act in respect of GST paid to investment managers. GMCL retained these investment managers in order to manage the investment funds held in the pension plans established by GMCL. Although it was GMCL that manufactured, assembled and sold vehicles, the services provided by the investment managers were found to be sufficiently connected to the commercial activities of GMCL.
(ii)
The definition of “commercial activity” requires that a part of the business that consists of making exempt supplies be notionally severed.
[32] Courts have concluded that where there are multiple businesses or business objectives, any part of the business that consists of making exempt supplies must be notionally severed. For example, in 398722 Alberta Ltd. v R, the Federal Court of Appeal addressed whether the taxpayer was required to “pay GST on the fair market value of an apartment building acquired solely to obtain approval for a new hotel development … .” The Federal Court of Appeal found that the company was not entitled to ITCs and stated that:
[22] Any business may consist of a number of components, each of which is integral to the business as a whole. The definition of “commercial activity” recognizes that possibility but requires, for GST purposes, that any part of the business that consists of making exempt supplies be notionally severed. The statutory definition dictates that the business of the respondent is not a “commercial activity” in so far as it consists of the rental of the units of the four‑plex. On that basis I agree with the Crown that the respondent is not entitled to an input tax credit to offset the GST payable on the self‑supply of the four‑plex.
[Emphasis added.]
[33] The Federal Court of Appeal denied the taxpayer’s claim for ITCs in 398722 Alberta Ltd. on the basis that the taxpayer was “fulfilling an obligation to meet another business objective”.
[34] In London Life Insurance Co. v R, the Federal Court of Appeal held that the taxpayer, whose business consisted of making exempt supplies, made a separate taxable supply to its landlord when it provided the landlord with leasehold improvements in return for leasehold improvement allowances. The Federal Court of Appeal noted that this conclusion was “consistent with the fact that under the leases, the improvements became the property of the landlords immediately upon installation.” Thus, the taxpayer’s business of supplying improved leasehold premises to its landlord was separate from its normal business, which was the provision of exempt supplies.
(iii)
The words of a written contract should be considered in light of the factual matrix of the contract.
[35] In Creston Moly Corp. v Sattva Capital Corp., the Supreme Court of Canada reviewed the principles of contractual interpretation within the context of appeals from commercial arbitration decisions. The Supreme Court of Canada stated that:
[50] … [c]ontractual interpretation involves issues of mixed fact and law as it is an exercise in which the principles of contractual interpretation are applied to the words of the written contract, considered in light of the factual matrix of the contract.
[36] The Supreme Court of Canada also turned its attention to the role and the nature of the surrounding circumstances in contractual interpretation and the nature of the evidence considered:
[57] While the surrounding circumstances will be considered in interpreting the terms of a contract, they must never be allowed to overwhelm the words of that agreement (Hayes Forest Services, at para. 14; and Hall, at p. 30). The goal of examining such evidence is to deepen a decision‑maker’s understanding of the mutual and objective intentions of the parties as expressed in the words of the contract. The interpretation of a written contractual provision must always be grounded in the text and read in light of the entire contract (Hall, at pp. 15 and 30‑32). While the surrounding circumstances are relied upon in the interpretive process, courts cannot use them to deviate from the text such that the court effectively creates a new agreement (Glaswegian Enterprises Inc. v. B.C. Tel Mobility Cellular Inc. (1997), 1997 CanLII 4085 (BC CA), 101 B.C.A.C. 62).
[58] The nature of the evidence that can be relied upon under the rubric of “surrounding circumstances” will necessarily vary from case to case. It does, however, have its limits. It should consist only of objective evidence of the background facts at the time of the execution of the contract (King, at paras. 66 and 70), that is, knowledge that was or reasonably ought to have been within the knowledge of both parties at or before the date of contracting. Subject to these requirements and the parol evidence rule discussed below, this includes, in the words of Lord Hoffman, “absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man” (Investors Compensation Scheme, at p. 114). Whether something was or reasonably ought to have been within the common knowledge of the parties at the time of execution of the contract is a question of fact.
…
[59] It is necessary to say a word about consideration of the surrounding circumstances and the parol evidence rule. The parol evidence rule precludes admission of evidence outside the words of the written contract that would add to, subtract from, vary, or contradict a contract that has been wholly reduced to writing (King, at para. 35; and Hall, at p. 53). To this end, the rule precludes, among other things, evidence of the subjective intentions of the parties (Hall, at pp. 64‑65; and Eli Lilly & Co. v. Novopharm Ltd., 1998 CanLII 791 (SCC), [1998] 2 S.C.R. 129, at paras. 54‑59, per Iacobucci J.). The purpose of the parol evidence rule is primarily to achieve finality and certainty in contractual obligations, and secondarily to hamper a party’s ability to use fabricated or unreliable evidence to attack a written contract (United Brotherhood of Carpenters and Joiners of America, Local 579 v. Bradco Construction Ltd., 1993 CanLII 88 (SCC), [1993] 2 S.C.R. 316, at pp. 341‑342, per Sopinka J.).
[60] The parol evidence rule does not apply to preclude evidence of the surrounding circumstances. Such evidence is consistent with the objectives of finality and certainty because it is used as an interpretive aid for determining the meaning of the written words chosen by the parties, not to change or overrule the meaning of those words. The surrounding circumstances are facts known or facts that reasonably ought to have been known to both parties at or before the date of contracting; therefore, the concern of unreliability does not arise.
[61] Some authorities and commentators suggest that the parol evidence rule is an anachronism, or, at the very least, of limited application in view of the myriad of exceptions to it (see for example Gutierrez v. Tropic International Ltd. (2002), 2002 CanLII 45017 (ON CA), 63 O.R. (3d) 63 (C.A.), at paras. 19‑20; and Hall, at pp. 53‑64). For the purposes of this appeal, it is sufficient to say that the parol evidence rule does not apply to preclude evidence of surrounding circumstances when interpreting the words of a written contract.
[Emphasis added.]
[37] There is a limitation on the weight given to the surrounding circumstances in the interpretation of a contract. As stated by the Supreme Court of Canada, the parol evidence rule precludes the admission of evidence outside the words of the written contract that would contradict or subtract from a contract that has been wholly reduced to writing.
D.
Review of the Key Agreements
(1)
Historical Overview of the Loyalty Program
[38] Before 2008, PC Bank owned and operated the Points Program. PC Bank issued PC Points when PC Bank customers used payment vehicles such as the PC MasterCard and other President’s Choice Financial products (“PCF Products”) offered through CIBC. CIBC paid PC Bank when such points were redeemed by its customers for rewards in Loblaws stores.
[39] As the operator of the program, PC Bank paid $0.65 to Loblaws for every $1.00 of notional value of PC Points redeemed at a Loblaws store. If the amount was paid in respect of a PC Point issued by CIBC to its customers, CIBC paid PC Bank $1.00 for each PC Point redeemed by a CIBC client. Loblaws also paid $0.0075 to PC Bank for every $1.00 of sales where PC Points were awarded to a Points Program member for purchases at Loblaws stores.
[40] On March 1, 2008, PC Bank sold its interest in the Points Program to PCSI. PCSI acquired all of the assets required to allow it to become the owner, administrator and operator of the Points Program (the “Loyalty Program”). Therefore, PC Bank was not operating the Loyalty Program during the tax periods at issue.
[41] Having divested itself of the Points Program, PC Bank entered into three agreements for the purpose of allowing it to issue points to the Cardholders. These agreements are the Loyalty Services Agreement, the Loyalty Expense Agreement and the Licence Agreement. These agreements were subject to various amendments, in some cases to correct alleged errors, as evidenced by an order of the Ontario Superior Court of Justice granting rectification thereof. The three agreements are discussed below.
(a)
The Licence Agreement
[42] Effective March 1, 2008, PC Bank obtained a non‑exclusive royalty‑free licence from PCSI granting it the right to issue PCB Points to Cardholders, subject to the terms and conditions of the Licence Agreement and of the Loyalty Program owned, administered and operated by PCSI. The Licence Agreement was rectified (the “Rectified Licence Agreement”). This rectification included the intentional deletion of the fee structure article of that agreement.
[43] The Rectified Licence Agreement expressly states that PC Bank desires to continue to participate in the Loyalty Program and acquire the right to issue PCB Points to its customers. As per article 2.1:
Licensor [PCSI] hereby grants, for the duration of the Term, a non‑exclusive, royalty‑free license to Licensee [PC Bank] the right to issue PCB Loyalty Points to Members who are Licensee’s [PC Bank’s] customers subject to the terms and conditions of this Agreement and the Loyalty Terms and Conditions.
[44] Under the Rectified Licence Agreement, PC Bank acknowledges that PCSI is the exclusive owner of the Loyalty Program, which includes the right to issue PCB Points. It is PCSI that has the “full authority” to “control the character, nature, features and redemption value of the [PCB Points] … .” In the Rectified Licence Agreement, PC Bank also acknowledges its liability for the redemption of all PCB Points.
(b)
The Rectified Loyalty Services Agreement
[45] The rectified Loyalty Services Agreement (the “Rectified Services Agreement”) sets out PCSI’s obligation to offer the Loyalty Program to PC Bank. Article 2(a.1) provides that:
Right to issue PCB Loyalty Points. Pursuant to the Licence Agreement, PC Bank has been granted non‑exclusive, royalty‑free licence to issue PCB Loyalty Points.
[46] The Rectified Services Agreement also stipulates that each PC Bank customer is automatically eligible to be a member of the Loyalty Program. That agreement also provides, per article 2(f), that:
…Members may redeem Loyalty Points at any Participating Location...as may be agreed to by Loblaw or PCSI, as applicable. Subject to the Loyalty Terms and Conditions, Loyalty Points may be redeemed against the purchase of any Eligible Product at the rate of $1.00 retail per 1,000 Loyalty Points or such other rate as may be agreed to by Loblaw or PCSI, as applicable, and or against any reward that may be offered as part of the Loyalty Program from time to time, including, without limitation, rewards made available on the pcpoints.ca, at the rates disclosed with such offers.
[47] Article 3(a) sets out the awarding of PCB Points by PC Bank as follows:
PC Bank is required to have certain of its products, services or PCF Payment Vehicles participate in the Loyalty Program. PC Bank may also award Loyalty Points as part of its marketing and customer acquisition and satisfaction strategy for any of its products or services.
[48] Article 5 sets out PCSI’s administrative responsibilities under the Rectified Services Agreement. Additionally, the administrative costs are the sole responsibility of PCSI.
(c)
The Rectified Loyalty Expense Agreement
[49] The rectified Loyalty Expense Agreement (the “Rectified Expense Agreement”) is an agreement made between PC Bank, PCSI and Loblaws. This agreement sets out the payments for Loblaws’ participation in the Loyalty Program. These payments include payments on the award of PCB Points and payments in relation to the redemption of PCB Points.
[50] The payments related to the award of PCB Points are set out in article 2(a) and can be summarized as follows:
Loblaw will pay PC Bank 0.75 cents for every $1.00 of sales where PCB Loyalty Points are awarded to members of the Loyalty Program for purchases made by such members in the Loblaw stores.
Loblaw will pay 0.375 cents to PCSI for every $1.00 of sales where PCB Points are awarded to a member of the Loyalty Program for purchases made by such member in Loblaw stores using a Payment Vehicle (other than a PCB Payment Vehicle).
[51] The payments related to the redemption of PCB Points are set out in article 2(b) and can be summarized as follows:
Loblaw will pay $0.35 to PC Bank for every $1.00 of notional value of PCB Loyalty Points accumulated by a member using a PCB Payment Vehicle and redeemed by such member.
PC Bank will reimburse/pay Loblaw $1.00 for every $1.00 of notional value of PCB Loyalty Points accumulated by a member using a PCB Payment Vehicle and redeemed by such member.
Loblaw will pay $0.35 to PCSI for every $1.00 of notional value of Loyalty Points accumulated by a member using a Payment Vehicle (other than a PCB Payment Vehicle) and redeemed by such member.
PCSI will reimburse/pay Loblaw $1.00 for every $1.00 of notional value of Loyalty Points accumulated by a member using a Payment Vehicle (other than a PCB Payment Vehicle) and redeemed by such member.
(d)
Summary of the Agreements
[52] There are numerous points that stand out from my review of the above agreements.
[53] First, PC Bank obtained the right to issue PCB Points to Cardholders to entice them to use their PC MasterCards frequently in order to accumulate PCB Points that could be used to acquire discounted or free goods from Loblaws.
[54] Second, PC Bank did so because the issuance of PCB Points was perceived as an attractive benefit for its Cardholders. In turn, this allowed PC Bank to grow its credit card business quickly.
[55] Third, PC Bank agreed to pay the redemption price for the cash value of the points because this was an obligation that it incurred as consideration for the issuance of the PCB Points.
[56] Fourth, the issuance of the PCB Points created a future liability to pay the redemption price for goods when the PCB Points were redeemed by Cardholders for rewards.
[57] All of the above establishes a direct link between the substantial income earned by PC Bank from its PC MasterCard business and the Redemption Payment made for the redemption of the PCB Points issued by PC Bank.
E.
Testimonial Evidence: The NITC Issue
[58] In respect of the NITC Issue, PC Bank called three witnesses: Ms. Sarah Ruth Davis, Mr. Ian Hanning and Mr. David Valenta.
[59] Ms. Davis is now retired. Prior to her retirement she held various positions related to LCL including Senior Vice President and Controller of the “enterprise”, Executive Vice President of Finance, Chief Financial Officer of LCL, and former President of LCL. She also served on the board of directors of PC Financial. Ms. Davis was the Chief Financial Officer of LCL during the relevant period.
[60] Mr. Hanning joined President’s Choice Financial as the Chief Financial Officer in 2019. This is subsequent to the tax periods at issue in the PC Bank Appeals. The record shows that Mr. Hanning had no personal involvement in the matters discussed here in the relevant years. Either way, in my opinion, there was nothing of note in Mr. Hanning’s testimony that requires comments from me.
[61] Mr. Valenta was called as an adverse witness by the Appellant. At the time of the trial, Mr. Valenta was employed by the Canada Revenue Agency (“CRA”) as a large case file manager. Prior to this, Mr. Valenta was a large file auditor with the CRA. Mr. Valenta was the auditor responsible for the PC Bank file. His testimony was short. He did not have anything relevant to say that was germane to the issue.
F.
Analysis of the NITC Issue
[62] The NITC Issue requires that I determine whether PC Bank made the Redemption Payment in the course of a commercial activity of PC Bank pursuant to subsection 181(5). Subsection 181(5) should be interpreted following the modern approach to statutory interpretation, which requires considering the text, context and purpose of that provision.
[63] The text of subsection 181(5) entitles a “particular person” (e.g. PC Bank) to claim NITCs for the tax fraction equal to the coupon value if certain conditions are met. First, a registrant (Loblaw) must accept as full or partial consideration for a taxable supply of property or a service a “coupon” (PCB Points) from a recipient (Cardholder). This coupon (PCB Points) may either be exchanged for property or a service (goods from Loblaws) or entitle the recipient (Cardholder) to a reduction on the price of the property or service. Second, a particular person (PC Bank) pays an amount to the supplier (Loblaw) for the redemption of the “coupon” (PCB Points). Third, this redemption payment is made in the course of a “commercial activity” of a particular person (PC Bank). A “commercial activity” is defined in subsection 123(1). A business that consists of the making of exempt supplies of a “financial service” is carved out of the “commercial activity” definition.
[64] The purpose of subsection 181(5) is to allow an issuer of a coupon to receive the tax fraction of the coupon value where it makes a redemption payment to the supplier, so long as the issuer does so in the course of a commercial activity. The parties agree that in this case, the only aspect of subsection 181(5) that is not met is whether PC Bank makes the Redemption Payment in the course of a commercial activity.
[65] As discussed below, I endorse the Respondent’s theory, which is that PC Bank became liable to make the Redemption Payments to Loblaws in the course of its MasterCard business. PC Bank issued the PCB Points to Cardholders to reward them for making purchases using their PC MasterCard.
(i)
The NITC Issue must be answered from the perspective of PC Bank.
[66] The question in dispute must be answered from the perspective of PC Bank, a distinct legal entity subject to the GST consequence with respect to its inputs, redemption expenses and supplies. This is clear from the part of subsection 181(5) that provides that “a particular person [PC Bank] at any time pays, in the course of a commercial activity of the particular person [PC Bank]”. The evidence must be examined to determine the reason or cause for the Redemption Payment. Stated differently, is the Redemption Payment linked to the making of exempt or taxable supplies by PC Bank?
(ii)
The Redemption Payments are made in the course of PC Bank’s provision of an exempt supply of a financial service—the PC MasterCard business—to Cardholders.
[67] In my opinion, the Redemption Payments were made in the course of PC Bank’s MasterCard activity, which involves the provision of exempt supplies of financial services to Cardholders. PC Bank issued the PCB Points to generate revenue from its PC MasterCard portfolio. PC Bank earned significant revenue from interchange fees that pales in comparison to the minimal revenue it received from Loblaws. PC Bank is a highly regarded legal entity licensed to carry on certain banking operations for profit. It is inconceivable to me that PC Bank made the Redemption Payments to lose money.
[68] PC Bank states that per the rectified agreements and viva voce evidence, PC Bank made the Redemption Payment in the course of a commercial activity. This activity was, “namely, its operation of the Loyalty Program with Loblaws.” However, the agreements are clear: PCSI, not PC Bank, owned and operated the Loyalty Program during the tax periods at issue.
[69] PC Bank has the right to issue PCB Points to its Cardholders pursuant to several agreements: the Rectified Licence Agreement, the Rectified Services Agreement, and the Rectified Expense Agreement (collectively, the “Rectified Agreements”). The Rectified Agreements allow PC Bank to offer PCB Points to Cardholders through PCSI’s Loyalty Program.
[70] PC Bank’s core business is banking, the provision of financial services. The Loblaw Companies Limited 2011 Annual Information Form (the “2011 Loblaw Report”) states that:
[PC Bank] makes available to consumers financial services under the President’s Choice Financial brand, including the President’s Choice Financial MasterCard® … which are provided by the direct banking division of a major Canadian chartered bank and the PC points Loyalty Program. ...PC Bank offers the President’s Choice Financial MasterCard® throughout Canada.
[71] Although the 2011 Loblaw Report predates the Rectified Agreements, these agreements do not change the fact that PC Bank’s general business is the provision of financial services to its customers.
(iii)
PC Bank has not established the nature of the alleged commercial activity.
[72] PC Bank has not identified the commercial activity for which it claims entitlement to NITCs. One of the principal arguments put forth by the Appellant is based on the fee structure as outlined in the Rectified Expense Agreement. In summary, in its written and oral submissions, PC Bank alleges that the $0.35 payment that Loblaws is required to make to PC Bank when $1.00 worth of PCB Points are redeemed is intertwined with the Redemption Payment. According to PC Bank:
In the present case, there is no dispute that PC Bank’s operation of the Loyalty Program is a commercial activity. The Respondent acknowledges as much in confirming that the 0.75 cent payment from Loblaws to PC Bank when points are issued, and the $0.35 payment from Loblaws to PC Bank when points are redeemed, are consideration for taxable supplies – namely, the “provision of services to Loblaws Inc., in connection with the PC Loyalty program.”
[Emphasis added.]
[73] PC Bank’s business consists of earning money from a profitable credit card business. Even from the consolidated reporting perspective (i.e. LCL), the reporting on the financial services segment (i.e. PC Bank) looks at how profitable the PC Bank credit card business was. It earns substantially all of its net income from that activity. It is my view that PC Bank obtained the right to issue PCB Points to Cardholders for the purpose of enticing them to acquire the PC MasterCard in the first place and thereafter for the purpose of encouraging Cardholders to use their PC MasterCards. The 2011 Loblaw Report made the following comment about financial services:
The Canadian bank card market is highly regulated and competitive. In the past year, the market has consolidated with two significant issuers selling their portfolios to major Canadian banks. As the market competition increases, customers expectations are being redefined, which include good value, exceptional service and programs that reward them for their loyalty. PC Bank as the issuer of President’s Choice Financial MasterCard® competes in this market. The unique value proposition of free groceries enables President’s Choice Financial MasterCard® to compete with the dominant players in the market.
[74] It is common knowledge that the Canadian banks use loyalty programs to grow their credit card businesses. PC Bank issued PCB Points and paid the Redemption Payment for PCB Points redeemed by Cardholders in order to have a competitive credit card offering. When Cardholders use their credit card, PC Bank earns, inter alia, significant interchange fees and interest on unpaid balances. In Ms. Davis’s testimony, she acknowledged that the financial benefit to PC Bank is the interchange fees when the PC MasterCard is used. Ms. Davis confirmed that this is because the PC MasterCard is a no‑fee credit card and that if cardholders are not using their PC MasterCard, “there’s no money to be made”.
[75] In this context, why does PC Bank pay the redemption price for the PCB Points redeemed in Loblaws stores? It does so because the issuance of the PCB Points creates a future liability that becomes due and payable when a Cardholder chooses to redeem PCB Points for purchases at participating locations owned or controlled by Loblaws. There is a direct link between the PCB Points that are issued in conjunction with an exempt financial service supplied by PC Bank to Cardholders and an expense that is paid when the PCB Points are redeemed by Cardholders.
[76] PC Bank’s business practice in issuing PCB Points and paying for their redemption costs mirrors that of CIBC when CIBC issues loyalty points to its clients and pays the redemption costs of the loyalty points. Why does CIBC obtain the right to issue points? It does so to entice the clients to acquire PCF Products from it. Once CIBC issues the loyalty points, it incurs a future liability to pay for the redemption cost. I fail to see any material difference between these two situations. In both cases, when points are redeemed for rewards, Loblaws enjoys a benefit. There are more customers shopping in its stores buying goods. Loblaws receives payment for the goods that it sells. The fact that Loblaws benefits when points issued by CIBC and PC Bank are redeemed does not explain why PC Bank and CIBC issue the points in the first place. PC Bank issues the points and pays their redemption price for the same reason CIBC does, namely, to earn income from the supply of financial services.
[77] I have difficulty reconciling the Appellant’s argument with normal commercial and business practices. It is unimaginable for me that the Appellant would accept to pay $1.00 to earn $0.35. Why would the Appellant issue points to lose money? My analysis conforms to the approach adopted by Lamarre J. in the 2009 Decision. In that case, Lamarre J. looked at the supply made by PC Bank when it issued the loyalty points. She did so because the issuance of the points created a future liability to pay the redemption price of the points when a Loyalty Program member chose to redeem them. She found that PC Bank was not entitled to NITCs on loyalty points awarded on President’s Choice Financial products and subsequently redeemed. This conclusion was based on the finding that the supply of the points in accordance with the agreement in effect at that time was part of the exempt supplies—financial services—offered by PC Bank through CIBC. These supplies were not subject to GST. Because financial services are exempt supplies, PC Bank did not make them in the course of a commercial activity.
(iv)
NITCs cannot be claimed from a consolidated entity perspective.
[78] The Appellant essentially frames the NITC Issue from the perspective of LCL—the enterprise or consolidated perspective. Ms. Davis testified at length from this vantage point. For example, Ms. Davis emphasized that the main purpose of the Loyalty Program was to “drive more retail traffic” to Loblaws.
[79] Ms. Davis emphasized that the PC Bank’s MasterCard revenue paled in comparison to the revenue generated from the retail business. For example, Ms. Davis pointed out that in 2011, PC Bank earned approximately $250 million in interest from credit card loans and approximately $191 million in interchange income while LCL’s retail operations generated in the range of $31 to $32 billion of revenue in the same period. For Ms. Davis, the proportion of revenue from PC Bank was a “very small portion” from a consolidated financials perspective.
[80] LCL is a public holding corporation that reports its results on a consolidated basis. How income or revenue is generated at the legal entity level does not matter in the grand scheme of affairs, provided that the entity level results can be consolidated with that of a parent. That is why executives of a public holding corporation make decisions from this perspective.
[81] What happens at the legal entity level matters for a host of reasons. First, PC Bank is a highly regulated entity. As a bank, it is required to report to the competent banking authorities on a legal entity basis to protect its creditors and ensure compliance with strict banking rules. Second, and more importantly, for the purpose of the present case, income tax and excise tax are levied on a legal entity basis. The reason for this is tied to the fact that Canada is a federation and the tax base is shared between the federal and provincial governments. For GST purposes, the legal entity, PC Bank, is required to report the GST that it collects and claims ITCs on its input, when allowed, on a legal entity basis.
[82] As noted earlier, the focus of subsection 181(5) is squarely on PC Bank. What caused PC Bank to make the Redemption Payment? After considering the testimonial evidence, my opinion remains the same. PC Bank issued the PCB Points to attract clients to subscribe for and, more importantly, thereafter use their PC MasterCards. This was done to grow PC Bank’s MasterCard operations. PC Bank made the Redemption Payment for the redeemed PCB Points as consideration for having issued the PCB Points in the first place.
[83] For a loyalty program to be successful, it must be attractive to all of the participants thereunder, otherwise it will likely fail. I will use the Loyalty Program to illustrate this point. There are three participants in the Loyalty Program. The members of the program are of vital importance. The program must be designed to entice a desired behaviour. If the rewards under the program were unattractive, potential customers would opt to acquire and use a credit card that offers rewards perceived to be more attractive. There are a great deal of attractive loyalty programs that PC Bank, PCSI and Loblaws undoubtedly had to take into account in designing the Loyalty Program at issue here. While LCL ensured that PCB Points could be redeemed at Loblaws stores, the program, in the eyes of the Loyalty Program members, was nonetheless perceived to be attractive. This is obvious based on the popularity of the PC Bank MasterCard.
[84] Ms. Davis, in her testimony, acknowledged that the PC MasterCard had to be attractive to be competitive with credit cards offered with loyalty program benefits from other institutions. In this context, the Loyalty Program benefits had to be attractive to allow PC Bank to grow its business. The Loyalty Program also had to take into account Loblaws’s intent. Loblaw benefited from the fact that Cardholders were incentivized to shop at Loblaws. Loblaws was also fully reimbursed the value of the rewards paid out to Cardholders.
[85] The Loyalty Program was win‑win‑win for all participants. This is why it was successful. The Appellant agreed to issue PCB Points and pay the Redemption Payment of the PCB Points for the same reason that CIBC did when it issued points to entice its clients to acquire PCF Products. Like CIBC, PC Bank issued PCB Points and paid the redemption price of the points in the course of its credit card business consisting of the sale of exempt financial services. In that context, PC Bank is not entitled to claim NITCs.
[86] For all of these reasons, PC Bank’s appeal with respect to the NITC Issue is dismissed.
IV.
THE FDR/TSYS ISSUE
[87] This section addresses whether the services provided by FDR/TSYS to PC Bank are exempt financial services. The parties agree that the services provided by FDR/TSYS, respectively, are a single compound supply. However, the parties differ on their characterization of these services under the Act.
[88] PC Bank did not self‑assess GST/HST on the consideration paid to FDR in respect of the FDR Supply. However, PC Bank self‑assessed and remitted GST/HST in respect of the TSYS Supply. After the 2010‑2012 Reassessments were issued, PC Bank claimed that it paid the tax in respect of the TSYS Supply in error.
A.
Position of the Parties: The FDR/TSYS Issue
[89] PC Bank’s position is that the services provided by FDR/TSYS are exempt financial services. According to PC Bank, the “essential character of the supply” provided by the FDR/TSYS is complex credit card processing and portfolio management services for PC Bank’s credit card business. The FDR/TSYS services are integral to the operation of PC Bank’s credit card business. PC Bank submits that the FDR/TSYS supplies are included by paragraphs (d), (i) and (l) of the “financial service” definition in subsection 123(1).
[90] PC Bank states that paragraph (d) applies because the supply made by FDR/TSYS was, inter alia, the processing of credit card transactions. PC Bank also relies on paragraph (i), which covers any services provided under an agreement relating to payments for which a credit card voucher has been issued, provided once again that such a service is not described in an Exclusionary Paragraph. PC Bank also indicates that paragraph (l) applies because, in general terms, that paragraph applies to supplies that consist of “the arranging for” the lending or payment of money subject to the application of the Exclusions.
[91] The Respondent submits that the FDR/TSYS services are taxable supplies. According to the Respondent, FDR/TSYS assist PC Bank in the administration of its credit card business by providing PC Bank with electronic systems that assisted PC Bank in the management of the data collected and used in the course of its business. Therefore, the predominant element of these services does not fit within paragraphs (a), (d), (i) or (l) of the “financial service” definition in subsection 123(1). In the alternative, in the event that I conclude otherwise, the Respondent states that exclusionary paragraphs (r.3), (r.4), (r.5) and/or (t) of the “financial service” definition in subsection 123(1) apply such that FDR/TSYS supplies are taxable supplies subject to GST/HST.
B.
Legislation
[92] The relevant paragraphs of the “financial service” definition in subsection 123(1) of the Act are set out below:
“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,
…
(d) the issue, granting, allotment, acceptance, endorsement, renewal, processing, variation, transfer of ownership or repayment of a financial instrument,
…
(i) any service provided pursuant to the terms and conditions of any agreement relating to payments of amounts for which a credit card voucher or charge card voucher has been issued,
…
(l) the agreeing to provide, or the arranging for, a service that is
(i) referred to in any of paragraphs (a) to (i), and
(ii) not referred to in any of paragraphs (n) to (t) …
(r.3) a service (other than a prescribed service) of managing credit that is in respect of credit cards, charge cards, credit accounts, charge accounts, loan accounts or accounts in respect of any advance and is provided to a person granting, or potentially granting, credit in respect of those cards or accounts, including a service provided to the person of
(i) checking, evaluating or authorizing credit,
(ii) making decisions on behalf of the person in relation to a grant, or an application for a grant, of credit,
(iii) creating or maintaining records for the person in relation to a grant, or an application for a grant, of credit or in relation to the cards or accounts, or
(iv) monitoring another person’s payment record or dealing with payments made, or to be made, by the other person,
(r.4) a service (other than a prescribed service) that is preparatory to the provision or the potential provision of a service referred to in any of paragraphs (a) to (i) and (l), or that is provided in conjunction with a service referred to in any of those paragraphs, and that is
(i) a service of collecting, collating or providing information, or
(ii) a market research, product design, document preparation, document processing, customer assistance, promotional or advertising service or a similar service,
(r.5) property (other than a financial instrument or prescribed property) that is delivered or made available to a person in conjunction with the rendering by the person of a service referred to in any of paragraphs (a) to (i) and (l),
…
(t) a prescribed service.
[Emphasis added.]
[93] Paragraph (t) of the “financial service” definition excludes a “prescribed service”.
[94] A prescribed service is described in section 4 of the Financial Services and Financial Institutions (GST/HST) Regulations (SOR/91-26) (the “Regulations”) as follows:
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 by virtue of a guarantee, an acceptance or an indemnity in respect of the instrument, but does not include a person who becomes so at risk in the course of, and only by virtue of, authorizing a transaction, or supplying a clearing or settlement service, in respect of the instrument.
(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.
(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, …
[95] As noted in the attached CIBC reasons for judgment, the definition of a financial service is complex.
[96] Subsection 123(1) of the Act defines a “financial service”. This definition consists of a list of services that may come within that term. These paragraphs are paragraphs (a) to (m) (the “Inclusions” or the “Inclusionary Paragraphs”). The “financial service” definition also lists services that are excluded from that definition. These paragraphs are paragraphs (n) to (t) (the “Exclusions” or “Exclusionary Paragraphs”).
[97] At this juncture, I observe that the Exclusionary Paragraphs overlap to some degree. For example, paragraph (t), excludes a “prescribed service” from the definition of a “financial service”. However, paragraph (t) is broad enough to also cover a service the predominant elements of which falls within paragraph (r.3). Paragraph (r.3) excludes from the “financial service” definition certain activities related to managing credit that are administrative in nature.
[98] For efficiency purposes, I will assume that the predominant elements of the supply here fall initially within one of the three Inclusionary Paragraphs—paragraphs (d), (i) or (l)—relied on by PC Bank. It is undisputed that, if a supply that falls within the scope of an Inclusionary Paragraph also falls within the scope of an Exclusionary Paragraph, then that supply will be excluded from the “financial service” definition. If I determine that none of the Exclusionary Paragraphs relied on by the Respondent apply, then I will return to this matter and specifically address whether the FDR/TSYS supply falls within the Inclusionary Paragraphs relied on by PC Bank.
C.
Review of the Case Law
[99] There are numerous cases that address whether or not a single compound supply falls within the “financial service” definition in subsection 123(1). The legal test applied to make that determination is generally a two‑step test. First, the predominant elements of the supply are identified based on an interpretation of the contracts between the parties. Second, whether or not the predominant elements fall within the statutory definition of “financial service” is determined based on the words of the Act.
[100] In Global Cash Access (Canada) Inc. v R, the Federal Court of Appeal addressed whether the single supply at issue in that case met the “financial service” definition. To do so, the Court set out a two‑step test:
[26] To determine whether that single supply falls within the statutory definition of “financial service”, the questions to be asked are these: (1) Based on an interpretation of the contracts between the Casinos and Global, what did the Casinos provide to Global to earn the commissions payable by Global? (2) Does that service fall within the statutory definition of “financial service”?
[101] At issue in Global Cash was whether the commissions paid by the corporate taxpayer (“Global”) to two corporations that operated casinos (the “Casinos”) were consideration for a “financial service” supplied by the Casinos. Global argued that the commissions were exempt from GST because they were paid as consideration for a “financial service”.
[102] Global’s business included providing casino patrons access to cash through dedicated computer terminals owned and installed by Global in the Casinos. Global gained access to the Casinos through contracts, the preamble of the which stated that Global would become a supplier of Funds Access Services within the Casinos, and that the Casinos would receive a commission for each completed transaction. The contracts also provided for a transaction volume incentive. The Federal Court of Appeal held that Global paid the Casinos a commission for all of the steps that it took to complete the transactions, which constituted a single supply of a service. The supply fell within paragraph (g) of the “financial service” definition and did not fall within any of the Exclusionary Paragraphs.
[103] In Great‑West Life Assurance Co. v R, the Federal Court of Appeal expanded on the two‑step test set out in Global Cash. The Court noted that the difficult part of the two‑step test is the second part. This is because of the following:
[48] … It requires a determination as to whether the supply is included in the definition of “financial service.” As part of this exercise, it is necessary to determine the predominant elements of the supply if it is a single compound supply. It is only the predominant elements that are taken into account in applying the inclusions and exclusions in the “financial service” definition.
[104] The Court also confirmed that the test for determining the predominant elements of the supply requires identifying the “parts of the service that resulted in the payment of the benefits”. At issue in Great‑West was whether fees paid by the corporate taxpayer—Great‑West Life Assurance Company (“Great‑West”)—to Emergis Inc. and Telus Health Solutions (collectively “Emergis”) were fees paid for a “financial service”. The fees were paid in connection with group health benefits offered by Great‑West to employers. The services provided by Emergis related to “receiving and adjudicating benefits claims from employees, and arranging for the benefits to be received on a real‑time basis.” These services were generally delivered electronically through a program that enabled the claims to be adjudicated quickly. Emergis also entered into agreements with pharmacies, which allowed prescriptions to be filled with the understanding that payments would follow.
[105] The Federal Court of Appeal explained that there is a two‑step process to determine whether a supply is a “financial service”: “The first question is simply to determine what services were provided for the consideration received. At this stage, the services should include all services and not just the predominant elements.” For step two, “it is necessary to determine the predominant elements of the supply if it is a single compound supply. It is only the predominant elements that are taken into account in applying the Inclusions and Exclusions in the ‘financial service’ definition.” The Federal Court of Appeal found that the Tax Court judge’s reasons suggested that the judge correctly “determined that the predominant elements of the supply were the parts of the service that resulted in the payment of the benefits.” Accordingly, Emergis provided a taxable supply of an “administrative service” to Great-West.
[106] More recently in Canadian Imperial Bank of Commerce v Canada, the Federal Court of Appeal addressed CIBC’s application for a rebate under section 261 of the Act for GST paid on the supply made by Aeroplan to CIBC. There was no dispute between the parties that Aeroplan made a single supply to CIBC. At issue was “what in particular was supplied as the single supply.” Because CIBC was the person liable to pay consideration under the agreements with Aeroplan, the characterization of the supply was made from the perspective of CIBC. The Court noted that, just like in Global Cash, the “agreement under which the consideration for the supply was paid by CIBC should play a dominant role in determining what was acquired for the amounts that were paid.”
[107] In Canadian Imperial Bank of Commerce v The Queen, at issue was whether CIBC paid GST in error on fees charged to it by Visa because Visa made an exempt supply of a “financial service”. The Tax Court judge held that Visa made a taxable supply of an “administrative service” and that Visa was not “a person at risk”. The Federal Court of Appeal reversed the Tax Court judge on the basis that he “committed a reversible error by making contradictory and irreconcilable findings concerning the nature and impact of the Visa supply.” The Federal Court of Appeal held that Visa made an exempt supply of a financial service and did not need to consider the alternative “person at risk” argument.
D.
Review of the Key Agreements
(i)
Service Agreement (the “FDR Agreement”)
[108] FDR provided services to PC Bank beginning after January 31, 2001 until December 10, 2009. The FDR Agreement sets out the services that were made available by FDR to PC Bank. These services are found in a lengthy and detailed list in Exhibit A of the FDR Agreement. As stipulated in that agreement, the types of services offered by FDR are grouped into two main categories: “General Services” and “Ancillary Services”.
[109] Section II of Exhibit A of the FDR Agreement sets out the General Services performed by FDR as follows:
II. General Services
A. FDR will provide Customer with an on‑line terminal facility (not the terminals themselves), on‑line access to Transaction Card processing software, adequate computer time and other mechanical Transaction Card services as more specifically described in the [user manuals].
B. Reports will be made available to Customer at Customer’s request from time to time in accordance with FDR’s Information Delivery Platform (IDP). FDR will shut off specific reports within five (5) business days of receiving such a request to do so from Customer and will not bill Customer for reports generated after such date.
C. Specific Services are defined in Sections IV, V and VI [of Exhibit A].
[110] Section III of Exhibit A of the FDR Agreement sets out in great detail the Ancillary Services provided by FDR. These Ancillary Services include:
a)
fraud management and detection services in conjunction with its proprietary software;
b)
services (human statistical analysis or reports) and products (software integrated into the FDR system) for use in connection with the Appellant’s risk management of its accounts;
c)
the Evolve application and licence, which Ms. Daksa Mody (“Ms. Mody”) explained to be a FDR system interface;
d)
the InfoSight software, which Ms. Mody also described as another FDR system interface; and
e)
FDR ROW/ROWnet Services, which will be provided by FDR or through the Appellant’s permitted access to licensed software and related documentation.
[111] Section IV of Exhibit A of the FDR Agreement sets out processing fee definitions and prices. For example, under the definition “Auto PIN Change”, each time a PC MasterCard holder uses the automated telephone system to change his or her PIN, FDR would bill PC Bank $0.79.
[112] Section V of Exhibit A of the FDR Agreement sets out credit‑related processing services as well as their definitions and prices per item.
[113] Section VI of Exhibit A of the FDR Agreement sets out the processing services provided by FDR and related definitions and prices per item. For example, a two‑cent fee is charged each time a PIN‑based transaction is processed by FDR.
[114] PC Bank replaced FDR with TSYS to provide a similar service that was previously offered by FDR. Ms. Mody testified that there was no material difference between the services provided by TSYS and FDR. This is apparent from a review of the recitals to the TSYS Agreement, which are discussed below.
(ii)
Processing Services Agreement (the “TSYS Agreement”)
[115] TSYS provided services to PC Bank beginning after December 10, 2009, pursuant to the TSYS Agreement. The recitals to the TSYS Agreement state as follows:
RECITALS:
A. PC Bank is currently engaged in the business of advancing credit to credit card holders, financing and managing the related accounts and receivables, and related financial services and may be engaged in other financial services in the future;
B. TSYS is engaged in the business of providing a broad range of innovative issuing and acquiring payment technologies, including credit card processing and account maintenance services;
C. PC Bank has selected TSYS, and TSYS has agreed to provide for the processing of credit card and other payment transactions of Cardholders and related account maintenance services, on an integrated basis, in accordance with the terms and conditions of this Agreement.
[Emphasis added.]
[116] The underlined words capture the essence of the TSYS supply. In short, TSYS is a supplier of “issuing and acquiring payment technologies”. It agreed to provide PC Bank “the processing of credit card and other payment transactions… and related account maintenance services, on an integrated basis … .”
[117] Article 4 and Schedule 4.1 govern the core services provided under the TSYS Agreement. The services supplied by TSYS include “all processing and account maintenance services”.
[118] The TSYS Agreement defines the “core processing services” as a variety of services that are performed by the TSYS system, including:
a) The acceptance and processing of credit card authorization requests;
b) Processing of new client applications through the TSYS system based on terms and conditions set out by PC Bank;
c) Processing the information relating to cardholder account transactions; and
d) Storage of data on the TSYS system.
[119] Schedule 4.1 of the TSYS Agreement sets out the processing services provided by TSYS to PC Bank. They are divided as follows: core processing services, optional processing services, miscellaneous services, and ancillary services.
[120] The core processing services supplied by TSYS to PC Bank include authorizing transactions in accordance with “the authorization control options selected by PC Bank within the TSYS System”; assessing and evaluating “new account application[s] according to the options selected by PC Bank”; receiving, processing and posting PC Bank customers’ transaction activity; maintaining customer data and providing PC Bank access to that data; and, as directed by PC Bank, generating, distributing and transmitting TSYS standard reports.
[121] The optional processing services supplied by TSYS to PC Bank include a portfolio management service, which “provides an automated behaviour score based on each Cardholder’s activity, Cardholder Account performance and associated risk”; fraud protection services; a management system, which “integrates applications, automates and streamlines business processes, and provides real‑time management operations … ”; and training and testing services.
[122] The miscellaneous services supplied by TSYS to PC Bank are “incidental” to the core and optional processing services, and they “include customized programming, consulting services, and custom Developments to the TSYS system”.
[123] Finally, the ancillary services supplied by TSYS to PC Bank include a data protection program; a dedicated TSYS relationship manager; and the maintaining and administering of relevant telecommunications systems.
E.
Testimonial Evidence
[124] In respect of the FDR/TSYS Issue, the Appellant called Ms. Mody as a witness. Ms. Mody is Vice President Customer Support COE, PC Bank (part of LCL). She joined PC Bank in 2005, first as a Director of Operations Strategy and Vendor Management. Between 2006 and 2014, Ms. Mody held the roles of Vice President of Operations and Vice President of Solutions Delivery. She held the latter roles during the relevant periods.
[125] The Respondent did not call any witnesses.
F.
Analysis of the FDR/TSYS Issue
[126] The parties agree that the FDR/TSYS supply consists of a single compound supply. I share the parties’ view on this point.
[127] The parties also agree on the framework that applies for the purpose of determining whether a supply is an exempt supply of a “financial service” or a taxable supply. The first step consists in determining “what services were provided for the consideration received”. The second step consists in establishing the “predominant elements” of the supply. In determining whether a single compound supply is a financial service or not, only the predominant elements of the supply must be considered.
(i)
Step 1: Elements of the supply
[128] I will begin my analysis of the elements of the FDR/TSYS supply with an overview of the process under which PC Bank makes credit card loans to its customers.
[129] A typical credit card loan made by PC Bank involves numerous parties. These include a Cardholder using his or her PC MasterCard to pay for goods or services with a merchant; the merchant presented with the PC MasterCard for payment of goods and services; an acquirer acting as an intermediary between MasterCard and the merchant; and a processor (either FDR or TSYS depending on the relevant period).
[130] The case law provides that the interpretation of the relevant agreements is key to establishing the elements of the supply. Under the FDR Agreement, the general services provided by FDR to PC Bank include:
an on‑line terminal facility (not the terminal themselves), on‑line access to Transaction Card processing software, adequate computer time and other mechanical Transaction Card services…
[131] Under the TSYS Agreement, the recitals set out the general services offered by TSYS to PC Bank. In short, TSYS is a supplier of “issuing and acquiring payment technologies”. It agreed to provide PC Bank “the processing of credit card and other payment transactions … and related account maintenance services, on an integrated basis … ”
[132] FDR/TSYS used automated systems to check and authorize credit in respect of the particular transaction based on the protocol and the terms and conditions set by PC Bank. An authorization of a credit card loan typically takes place in “milliseconds”.
[133] Ms. Mody stated that the authorization process is automated because it must be frictionless for Cardholders. If there are delays, a Cardholder may seek to use a different means of payment.
[134] To avoid fraud, the automated system is able to identify unusual transactions. For example, if a card is used for payment on the same day in Canada and in a foreign country, this may indicate that the card has been stolen. Similarly, the automated process can identify large purchases that are made quickly on the card and that do not correspond to a Cardholder’s normal spending pattern. In both cases, the authorization process may be slowed down to allow for further verification; the Cardholder may be called by someone from FDR/TSYS to verify the flagged transactions.
[135] In all cases, FDR/TSYS, through the use of the automated systems and follow‑up security and authorization procedures, are applying security protocols established by PC Bank. In short, they provide the service as agent for PC Bank using the automated security protocol approved by PC Bank. The automated systems also verify other critical information, such as whether the request for a credit card loan is within the Cardholder’s credit card limit.
[136] Like the billing scheme of the FDR Agreement, the TSYS Agreement’s billing scheme was on a per‑item basis. As Ms. Mody explained, “… each component of a decision that TSYS makes for us generally has a separate billing element associated with it.” Ms. Mody went on to explain that PC Bank was not charged one fee for TSYS services, but each item processed by TSYS was billed separately to PC Bank.
[137] Ms. Mody described TSYS as “this neural network that takes information, transactions, customer behaviour, et cetera, and processes that information, working with PC Bank strategies. And they … help us manage our portfolio both from a risk perspective and a growth perspective.” By this I understood that the TSYS system processed the request for authorization in real time to enable the Cardholder to purchase goods and services by means of a credit card loan and performed related administrative and credit management services within the parameters set by PC Bank. Undoubtedly, PC Bank could not conduct its business without the benefit of an automated credit card authorization and processing system.
(ii)
Step 2: The predominant elements of the supply
[138] I believe that the predominant element of the FDR/TSYS supply is the automated services provided by the FDR/TSYS system for and on behalf of PC Bank. This is the Respondent’s alternative argument. In my opinion, the predominant element of this supply is described in Exclusionary Paragraph (r.3).
[139] The June 10 Technical Notes describe the scope of application of paragraph (r.3) as follows:
New para. (r.3) is added to the definition to clarify that the definition “financial service” does not include a service of managing credit in respect of credit or charge cards, or in respect of credit accounts, charge accounts, loans accounts or accounts in respect of any advance, where the service is provided to a person granting, or prospectively granting, credit in respect of those cards or accounts. A service of managing credit includes a service provided to the person of:
• checking, evaluating or authorizing credit;
• making decisions on behalf of the person relating to a grant, or an application for a grant, of credit;
• creating or maintaining records for the person relating to a grant, or an application for a grant, of credit or in relation to the cards or accounts; or
• monitoring another person’s payment record, or dealing with payments made, or to be made, by the other person.
[Emphasis added.]
[140] The June 10 Technical Notes mirror, to a large extent, the final text of Exclusionary Paragraph (r.3).
[141] The language of paragraph (r.3) indicates that “managing credit” is broader in scope than what may be commonly understood by that expression. In a narrow sense, credit management refers to the process of granting credit to borrowers based on agreed‑upon terms and conditions, recovering payment and ensuring that borrowers abide by the terms and conditions of their loans. The Appellant bases its argument on this narrow definition of “managing credit”.
[142] The services described in paragraph (r.3) are defined to include checking or authorizing credit; making decisions on behalf of the person in relation to a grant, or application for a grant, of credit; creating or maintaining records in connection with the foregoing (in the instant case, the records are stored in digital format); and monitoring another person’s payment record. Thus, the term “managing credit” for the purpose of paragraph (r.3) is broad.
[143] The Appellant argues that the FDR/TSYS supply falls outside of paragraph (r.3) on the basis that the “essential character of the supply provided by FDR and TSYS … is complex credit card processing and portfolio management”, not “credit management”. In short, according to the Appellant, PC Bank could not conduct its business without the services offered by FDR/TSYS. Ms. Mody testified that without TSYS, PC Bank’s credit card business could not operate. While that is true, whether a service is essential or not or integral or not to a money‑lending business is not a characteristic that precludes the application of paragraph (r.3).
[144] As noted above, the purpose of paragraph (r.3) is to exclude credit management services, described in a broad sense, from the “financial service” definition. Proper credit management is the lifeblood of all money‑lending businesses. Poor credit management can lead to large loan losses and potential business failure.
[145] The main service offered by FDR/TSYS was the automated management and authorization of credit in real time, on behalf of PC Bank, based on the parameters and protocols established by PC Bank. These protocols included measures designed to detect credit fraud and to ensure that the terms and conditions under which PC Bank wishes to grant a credit card loan to a Cardholder are satisfied. All of this is done to avoid loan losses for PC Bank.
[146] The Appellant, in its written and oral submissions, relies a great deal on CIBC (Visa). In my opinion, the Appellant overlooks the fact that the Federal Court of Appeal was dealing principally with Exclusionary Paragraph (t), which excludes so‑called “administrative services”. In addition, there are significant differences between the characteristics of services supplied by Visa in that decision and the FDR/TSYS supply in the instant case.
[147] In CIBC (Visa), at issue was whether CIBC paid GST in error on fees charged to it by Visa because Visa made an exempt supply of a “financial service”. The Tax Court judge held that Visa made a taxable supply of an “administrative service” and that Visa was not “a person at risk”. As I explained earlier, the Federal Court of Appeal reversed the decision of the Tax Court judge on the basis that he “committed a reversible error by making contradictory and irreconcilable findings concerning the nature and impact of the Visa supply.” As explained by the Federal Court of Appeal:
[56] … On one hand, he found (at paragraphs 92 and 95 of his reasons) that Visa’s services “form an essential part of the ability for CIBC to offer credit card based services to their clients,” and that they “[give] CIBC customers the ability to purchase goods and services anywhere in the world without CIBC having to individually contact each merchant to set up payment arrangements with them.” He added that “[i]f CIBC was forced to create such a payment network on its own, even if technically feasible, this network would invariably be much less widely accepted than the one offered by Visa.”
[57] On the other hand, in concluding (at paragraph 116) that the services provided by Visa were, like those considered in GWL TCC, “quintessentially administrative in nature,” the Tax Court judge stated that “[a]t its most basic level […], the benefit that Visa offered CIBC was cost saving and logistical simplification.”
[148] In deciding that the Visa credit card service was not analogous to the service provided by Emergis in Great‑West, the Federal Court of Appeal reasoned as follows:
[63] In the face of this evidence and the evidence concerning the operation of the Visa payment system, I would find, consistent with the Tax Court judge’s findings at paragraphs 92 and 95 of his reasons, that Visa’s services “form an essential part of the ability for CIBC to offer credit card based services to their clients,” that they “[give] CIBC customers the ability to purchase goods and services anywhere in the world without CIBC having to individually contact each merchant to set up payment arrangements with them,” and that “[i]f CIBC was forced to create such a payment network on its own, even if technically feasible, this network would invariably be much less widely accepted than the one offered by Visa.” To this I would add that Visa’s services relieve CIBC and other issuers of the need to investigate and analyze the risk profile and solvency of the merchants that accept credit cards in payment for goods and services. To describe the benefit that CIBC obtained from Visa’s services as merely “cost saving and logistical simplification,” and on that basis to describe the services as “quintessentially administrative,” does not, in my view, adequately recognize the reality of the benefit that CIBC derived.
[64] Nor can it properly be said, in my view, that the Visa payment network differs from that provided by Emergis in GWL TCC only in scale and not in substance. In GWL TCC, the Tax Court was able to find that the supply by Emergis did not alter the substance of what was being done. As the evidence cited above makes clear, that is not the case here.
[65] These findings mean that all that is left as the basis for the Tax Court judge’s conclusion on “administrative service” is his finding that, like the system operated by Emergis, the Visa network operated “with minimal decision making involved.” But in my view, this factor is not capable on its own of supporting the conclusion that the Visa supply was an “administrative service,” particularly when Visa sets all of the rules of the payment network and maintains decision‑making authority in the application of those rules.
[Emphasis added.]
[149] The Federal Court of Appeal held that Visa made an exempt supply of a financial service and did not need to consider the alternative “person at risk” argument.
[150] The Appellant claims that paragraph (r.3) is inapplicable because this Court held in CIBC Visa that the services provided by Visa did not include “the responsibility for authorizing the credit”. Credit card loan approvals were the responsibility of CIBC, the issuer of the card.
[151] Although not expressly stated, the Appellant appears to suggest that the same observation applies here because PC Bank, and not FDR or TSYS, is the one that establishes the terms and conditions and the circumstances under which credit card loans are made to Cardholders.
[152] I see nothing in the text of paragraph (r.3) that suggests that a service that consists of processing authorization requests via an automated system as agent for the issuer of a credit card is excluded under paragraph (r.3). In fact, the text and purpose of the provision suggest otherwise.
[153] Undoubtedly Parliament was aware of the fact that responsibility for credit management is an essential function for a moneylender. This authority is not the type that would be delegated to a third party as a principal unless the third party assumed the credit risk. To do so would create a misalignment between the lender, who assumes a risk by making the loan, and the third party, who does not bear such a risk in these circumstances. Therefore, in order for paragraph (r.3) to have meaning, I believe that the scope of paragraph (r.3) covers all services related to credit management, including those undertaken by a third party on behalf of the issuer of a credit card.
[154] In my opinion, Parliament used exclusionary language in paragraph (r.3) because the Inclusionary Paragraphs, particularly paragraph (l), were interpreted expansively prior to the 2010 amendments.
[155] Outsourcing to third parties by financial service providers often takes place to achieve greater efficiency and cost savings. If the predominant elements of the outsourced service are described in an Exclusionary Paragraph, the consequence is that the supply is a taxable supply and the financial service provider that consumes the input in the making of exempt supplies of financial services must, at least initially, bear the GST as an expense. I surmise that PC Bank considered that the cost and efficiency savings attributable to the outsourcing of services to FDR and then to TSYS was of greater value than the GST that PC Bank self‑assessed on the TSYS supply.
[156] Ms. Mody suggested that the substance or essence of the FDR/TSYS supply could best be described as the brains of PC Bank’s credit management function. I disagree. Unlike Visa, FDR/TSYS did not set the rules of the payment network and maintain decision‑making authority in respect thereof; PC Bank did so by setting the parameters and protocols under which credit card transactions would be authorized by FDR and TSYS on its behalf. Nonetheless, it remains that the authorization of credit card loans by FDR/TSYS on behalf of PC Bank falls within the description of credit management services specifically included by Parliament under Exclusionary Paragraph (r.3). Data processing and record keeping services are also described in that paragraph.
[157] As a final observation on Ms. Mody’s testimony, I note that her statements regarding the importance of the FDR/TSYS services are inconsistent with the services as described in the key agreements. PC Bank set the terms and conditions under which it would allow credit card loans to be approved on its behalf. In these circumstances, I am inclined to place greater weight on my interpretation of the key agreements rather than on Ms. Mody’s somewhat embellished testimony.
[158] The FDR/TSYS services are significantly different than the attributes of the Visa services as noted by the Federal Court of Appeal in CIBC (Visa). CIBC (Visa) differs from the present appeals because Visa was not acting as agent for CIBC when it provided its services to CIBC. CIBC did not have the right to direct or control how Visa would provide services to it. In the present appeals, the evidence shows that the opposite is true. PC Bank sets the terms and conditions pursuant to which FDR/TSYS authorizes credit card loans on PC Bank’s behalf. Stated differently, Visa operated the Visa payment system based on the rules that it established; issuers of Visa credit cards were obligated to follow these rules. This is not the case for the services prescribed by FDR/TSYS.
[159] CIBC (Visa) also differs from the present appeals because, although the Federal Court of Appeal did not have to decide whether Visa was a “person at risk” given that the service Visa supplied was not an “administrative service”, the evidence showed that Visa incurred significant payment obligations on its own behalf. As the Federal Court of Appeal explained, Visa was exposed to a variety of significant risks, including settlement risk, sovereign risk, foreign exchange risk, and merchant risk. While CIBC bore fraud risk responsibility, Visa regularly analyzed and responded to fraudulent transactions and CIBC was required “to follow Visa‑specified anti‑fraud requirements and controls.”
[160] In comparison to Visa, FDR/TSYS bore very little risk. The Appellant argued that TSYS “is liable for the full value of the contract—$80 million—in the event that any of the data that it processes, stores, and analyses is leaked.” This is a standard indemnity that one would expect to be included in contracts where confidential information may be disclosed. It is worth noting that the indemnity that TSYS provided to PC Bank is included in a section of the TSYS Agreement that sets out the limits to TSYS’s liability. The indemnity for breach of confidential information is limited to the value of the contracts or $80 million even though the loss suffered by PC Bank may very well be significantly greater.
[161] While the above factors are irrelevant to the determination as to whether Exclusionary Paragraph (r.3) applies to the FDR/TSYS services, I am inclined to believe that the FDR/TSYS services are also excluded from the definition of a “financial service” by virtue of paragraph (t). Needless to say, this is relevant only if I am wrong regarding the application of paragraph (r.3).
[162] For all of these reasons, PC Bank’s appeals as they relate to the FDR/TSYS Issues are dismissed.
V.
SUMMARY
[163] In summary, PC Bank’s appeals are allowed in part only. The reassessments are returned to the Minister for reconsideration and reassessment to allow solely the followings adjustments:
- PC Bank is entitled to a reduction of the GST/HST assessed by the Minister, the whole in accordance with the Consent to the Order attached hereto as Appendix III.
- PC Bank is entitled to additional operational ITCs of $88,674 in the 2009 Period pursuant to subsection 169(1) of the Act in accordance with the parties’ agreement as set out in paragraph 53 of the PASF.
- PC Bank is entitled to a rebate for tax paid in error in the 2011 Period under subsection 296(2.1) of the Act in the amount of $556,1363.01, in accordance with the parties’ agreement as set out in paragraph 54 of the PASF.
Signed at Magog, Québec, this 19th day of July 2022.
“Robert J. Hogan”
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