9.9 Example case: the VAT treatment of a voucher (or: points) based loyalty scheme operated by a ‘loyalty business’ (e.g. Nectar points or Air Miles).

I will now apply the above principles to a complex example, based on an existing loyalty management scheme, example of which are ‘Nectar Points’1 in the UK and ‘Air Miles’2 in the Netherlands. The loyalty scheme is operated by a business that offers the loyalty (management) scheme to other businesses, usually to only one business per sector (e.g. one retailer, one petrol station chain, one financial services provider etc.). The organiser of the scheme keeps accounts for customers, who will receive a certain amount of ‘points’ when spending a defined amount of money when purchasing goods or services from the associated businesses. These businesses will pay the organiser of the scheme an agreed amount per point issued, because they believe that customers will be persuaded to purchase (more of) their goods or services because they will receive these coveted ‘points’. Points can be used by the customers to purchase goods or services from (other or the same) associated businesses, either by only paying with the points or by partially using the points and paying the remaining amount in a different way. The organiser will pay the businesses that accept these 'points’ an agreed amount per point, which is lower than the amount received for issuing the points. Businesses accept these points for the same reason they pay for issuing them: they believe that (potential) customers will be persuaded to purchase (more of) their goods or services because they can ‘save points for free goods or services or goods or services at a discount’.

On 13 March 2013, the Supreme Court of the United Kingdom gave judgment on (some of) the VAT issues surrounding this scheme.3 I will start with a factual description of the (complex) scheme, based on this case, which I will reproduce in components of a schedule, which I will include as a whole at the end.

A member of the scheme (Customer) has an account with Issuer, who issued a Card to Customer for collecting and redeeming ‘points’. When a member purchases goods or services from retailer (Supplier 1) that has agreed with Issuer to participate in the scheme in relation to the issue of ‘points’, Supplier 1 swipes the Card and Customer's account with Issuer is electronically credited with a number of points.

In the examples below, the applicable VAT rate is 25%. The customer is a business that can fully deduct VAT. Thin arrows represent cash, white arrows represent vouchers, grey arrows represent loyalty programme related services and black arrows represent supplies made by the participating businesses.

In the example below in Diagram 1, Customer purchases items with a (VAT inclusive) value of Euro 100 at Supplier 1, for which he is rewarded 10 points on his Card account. Supplier 1 will have funded (or will fund) these points by paying 10 for these points to Issuer.Issuer will charge a service fee of 10.5 to Supplier 1, in which the price of the points is included. Effectively, Supplier 1 pays 0.5 for a service that is provided to him by Issuer as well as 10 for the points awarded by Issuer to Customer. Supplier 1 has to remit 20 VAT to the Tax Authorities for his supply to Customer and he can deduct 0.1, i.e. the VAT on the service provided to him by Issuer. Customer can deduct the VAT on his purchase (i.e. 20) from the Tax Authorities in this example.

In Diagram 2, Customer is then entitled to use the 50 points to receive goods or services with a value of 100, at a reduced cost (i.e. for an additional payment of 50), from a retailer (Supplier 2) that has agreed with Issuer to participate in the scheme in relation to the "redemption" of points. When Customer receives goods or services from Supplier 2, this retailer swipes the Card and Customer's account with Issuer is electronically debited with the number of points which have been redeemed. Issuer will reimburse Supplier 2 for the supply made to Customer in return for the points by paying 50, and he will provide a service (for consideration, to the amount of 5) to Supplier 2 as well. These amounts will be settled.

For the supply of goods, for which he receives 50 from Customer and 50 from Issuer, Supplier 2 will have to remit 20 VAT to the Tax Authorities. Issuer will have to remit 1 VAT to the Tax Authorities for his services to Supplier 2, and Supplier 2 can deduct this VAT. Customer can deduct 10 VAT on his purchase.

The scheme involves three (or four) parties:

(1) the promoter of the scheme, Issuer;

(2) the members of the scheme ("Customer");

(3) retailers of goods and services ("Supplier 1"), who pay for their customers, if they produce a Card, to have points credited to their accounts with Issuer when they have purchased goods or services and their cards are swiped; and

(4) other retailers of goods and services ("Supplier 2"), from whom Customer receives goods and services, at no cost or at a reduced cost, when his Card is swiped and points are debited to their accounts.

The last two parties can be one category if all businesses that fund points upon purchase of their goods and services also accept these points in return for their goods and services.

The scheme depends upon a network of contracts between Issuer and these three parties:

First, Issuer agrees with Customer the terms upon which his account is operated, including an obligation on the part of Issuer that it will ensure that Customer can obtain points when he purchases goods or services from participating retailers (e.g. Supplier 1), and that it will ensure that goods and services are made available to Customer at no cost, or at a reduced cost, when he redeems his points at participating retailers (e.g. Supplier 2). Issuer provides Customer with information about the identities of the participating retailers (e.g. Supplier 1 and Supplier 2), the particular goods and services which can be obtained using the points, and the number of points required in order to receive the goods or services in question.

Secondly, Issuer agrees with participating retailers (e.g. Supplier 1) that they will ensure crediting Customer’s account with the points for which the retailers have agreed to pay (i.e. that they will ‘fund’) and that Issuer will ensure that goods and services are made available to Customer upon redemption of these points (this is what would make shopping at these retailers more attractive: they issue (fund) points). In return, the retailers make payments to Issuer based on the number of points credited to Customer’s account, at an agreed value per point, together with a(n annual) marketing fee. Issuer grants these retailers the exclusive right to participate in the scheme in a particular market sector. The contract entered into between Issuer and these retailers provides that their agreement does not create a relationship of partnership or agency.

As a third point, Issuer agrees with other (or the same) retailers (e.g. Supplier 2) that they will provide Customer with specified goods and services upon the redemption of the applicable number of points, and that Issuer will reimburse the redeemed points based on the number of points redeemed, at an agreed value per point. (That value may be lower than the value agreed with the ‘funding retailers’ such as Supplier 1). It can be that Supplier 2 is required to supply some services to Issuer, e.g. providing him with information about problems affecting the quality or availability of goods and services, providing specific customer data and other information which Issuer requires for marketing purposes, granting permission for the use of his name and brand in marketing material, handle complaints by Customer and replace faulty goods.

The three contracts involved in the scheme are separate from, and should not be confused with, the agreements between Supplier 1 and Customer, or the agreements between Customer and Supplier 2. In particular, the purchase of goods or services by Customer from Supplier 1 is a separate transaction, between different parties, from the crediting of points by Issuer to Customer'saccount, or the payment of Issuer by Supplier 2in respect of those points.

The ‘points’ are a means of keeping account of Customer's contractual rights to receive goods and services at no cost or at a reduced cost. Supplier 1 pays Issuer for the grant of those rights to collectors. Issuer uses part of its receipts from Supplier 1 to pay Supplier 2 to provide Customer with the goods and services in accordance with their rights. Issuer derives its profits from the difference between its receipts from Supplier 1 and its payments to Supplier 2.

Diagram 3 shows all relevant transactions, where the applicable VAT rate is 25%, Supplier 1 ‘awards’ his Customer 1 point for every Euro 10 spent (which is actually issued or recorded by Issuer and funded by Supplier 1), Supplier 2 accepts 1 point as payment for every cash unit of an advertised price and Issuer charges (settles) 5% of the value of the point awarded by/issued on behalf of Supplier 1, therefore charging 95/100 cash units from Supplier 1 for every point issued and 10% of the points value in cash units with Supplier 2. In order to visualise a ‘closed circle’ of transactions, I changed the above examples so that all points funded by Supplier 1 are actually redeemed at Supplier 2 as part payment for his supply. This means that Customer uses 10 points and Euro 90 for purchasing goods or services from Supplier 2: