The taxpayer encouraged the use of its credit card by agreeing that cardholders would earn points based on the dollar amount of eligible purchases charged to their credit cards. Those points could then be redeemed for rewards. The taxpayer, in turn, had agreements with a related party and with various third parties (the “participants”) that, consequent upon a cardholder redemption, the taxpayer would pay an agreed amount to the applicable participant to acquire the applicable reward for delivery to the cardholder. Points expired only in very limited circumstances.
Before finding that the taxpayer could not recognize a deductible expense as the rewards were earned, and that the applicable deductions were deferred until the points were redeemed, the Directorate stated:
[T]he courts have held that an expense will not be considered to have been incurred unless the taxpayer has an obligation to pay money to someone [citing Burnco Industries, Northwood Pulp and General Motors]. … [and] that a legal obligation to pay under contract does not exist until all contractual preconditions to which the payment relates are fulfilled [citing Wawang Forest Products].
Here, although the program provided a cardholder with the option and means to redeem points, the cardholder’s entitlement to a specific reward was dependent inter alia on a redemption request being made, and it was only upon the occurrence of this event that a cardholder selected the particular reward - and it was only then that both the amount of the reward and the participant who would supply it (and, therefore, the party whom the taxpayer would ultimately be required to pay an amount to) became known. Thus, when the points were earned, there was no identifiable debt owing to an identifiable creditor who could make a legally enforceable claim against the taxpayer in respect of the points, and no expense had yet been “incurred.” The Directorate stated:
Concluding otherwise would lead to inappropriate results in many situations, given that it is common commercial practice for parties to contract for the provision of goods or services, the fulfillment of which necessitates expenses to be incurred in the future.