Used mileage points interpreted as sales allowance deductible from tax base
If a business operates a customer loyalty program together with other business, in which the amount of mileage points granted for the customers’ primary transaction is deducted from the purchase price of the customers’ secondary transaction and those customers only have to pay the remaining price, the amount deducted from the purchase price during the secondary transaction should not be additionally included as the value of supply(i.e. should not be subject to VAT) of the secondary transaction(Summary of Supreme Court 2015 du 58959, 2016. 08. 26.).
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A Customer Loyalty Program is often used by businesses to attract and secure loyal customers who frequently purchases goods or services. Such customer loyalty program grants certain redeemable bonus points to customers in certain proportion(in part or whole) to their purchase amount in the form of mileage points or gift certificates (or collectively “Mileage Points”).
Lotte Shopping Co., Ltd (“Lotte Shopping”) runs a Customer Loyalty Program that rewards customers -who purchase goods or services at its department stores (Lotte Department Store), supermarket chains (Lotte Mart), or movie theatres (Lotte Cinema)- with mileage points or gift certificates that can be redeemed at 0.1% to 1% of their purchase. According to Lotte Shopping’s Customer Loyalty Program, customers can subsequently use such Mileage Points to get a discount when they purchase goods or services at the aforementioned businesses (“Secondary Transactions”).
Most businesses including Lotte Shopping had filed and paid VAT on such Mileage Points used in Secondary Transaction during their past tax practice. This was because the Enforcement Decree of the VAT Act (prior to amendment) provided that if a business reserves mileage points for its customers in certain proportion to their purchase, and later the customers pay with their mileage points in part or whole in consideration for goods or services supplied, such mileage points used shall be accounted for the value of supply for VAT purposes.
Nonetheless it has long been debated whether the Mileage Points -when used for payment of Secondary Transaction- should be viewed as a sales bounty (a consideration for money or money equivalent) on which VAT is generally imposed, or should be viewed as a sales allowance (a discount to purchase price), which is not subject to VAT.
For example, in case where a customer uses 33,000 points to purchase a product that costs KRW 110,000 and if such points (33,000) used are not considered a sales allowance, then the business should bear KRW 10,000 (1/11th of KRW110,000) for VAT. On the other hand, if the mileage point used is considered a sales allowance for VAT purposes, then the business should only bear KRW 7,000 (1/11th of KRW 77,000) for VAT.
Lee&Ko, representing Lotte Shopping Co., Ltd. for the administrative litigation(cancellation of VAT) in regards to Mileage Purchase transactions, actively contended that i) Mileage Purchase that customer uses is a “sales allowance” which should not be accounted for in determining the tax base for VAT, ii) inclusion of mileage points or gift certificates used in Mileage Purchase to the tax base for VAT would result in double taxation, and iii) such inclusion would fall out of the basic principle of imposition of VAT where a supplier (not the recipient who is a taxpayer in this regard) is responsible for collecting (and remittance thereof) VAT of the recipient(the “Lotte Shopping Case”). However, Lotte Shopping’s arguments of the Lotte Shopping Case were denied at both the trial and appellate level due to unfavourable precedents on similar merits represented by other law office.
Lee & Ko, nevertheless, successfully led the Supreme Court to hold the case for the taxpayer through a full bench decision process (the Supreme Court postponed rendering judgment of the aforementioned unfavourable precedents, and decided on the Lotte Shopping Case first). The Supreme Court (Supreme Court 2015 du 58959, 2016. 08. 26) held that most of the mileage points are used as a direct deduction from the value of supply by specific terms that have been agreed between the business and customers prior to Secondary Transaction, therefore should be viewed as a sales allowance not subject to VAT. Even if settlement is made by other businesses (not by individual customers) per the terms of a settlement agreement between businesses, this should not be viewed as a consideration provided in return for mileage points consumed in Secondary Transaction. In addition, gift certificates similar to mileage points serve as a discount to reduce purchase price in Secondary Transaction, therefore, customers are viewed to use gift certificates as a direct deduction from the value of supply per the terms pre-determined with Lotte Shopping. Therefore, mileage points and gift certificates should be treated as a sales allowance that directly reduces the value of supply and thus shall not be subject to VAT in Secondary Transaction.
The significance of this case is that it is the first Supreme Court decision on the application of the VAT rules to Mileage Purchase (i.e. whether the used amount of mileage points or gift certificates should be included in the tax base for VAT). Lee & Ko expects that there will be a rush of requests for VAT correction by many businesses based on this ruling. Also, the Lotte Shopping Case would be particularly useful to those businesses sharing a mileage point system such as OK-CASHBACK, since according to the Supreme Court’s judgment on the Lotte Shopping Case a post settlement could be interpreted as a separate transaction for VAT purposes and thus viewed as a sales allowance (which is not subject to VAT).
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Jae Hoon Kim (email@example.com)
Byeong Jun Son (firstname.lastname@example.org)