Redemption of Credit Card Reward Points is a Taxable Income: US Court

Executive Summary

Internal Revenue Service (IRS) has a longstanding policy of not taxing credit card rewards. The rationale behind this is that the rewards itself acts as a discount on the property or services being purchased by the consumer. However, in an interesting ruling in the case of Konstantin Anikeev and Nadezhda Anikeev v. Commissioner of Internal Revenue [2021] 127 taxmann.com 612 (TC-US), the United States Tax Court held that the redemption of credit card reward points, which are earned from buying ‘cash equivalents’, shall be liable to tax. The Court held that the reward received in connection with the purchase of a gift card constitutes a rebate. However, buying money order and reloading cash into debit cards is nothing other than cash transfers. Thus, the reward received in connection with the direct purchase of these items did not constitute rebates and were included as taxable income in the cardholder’s hands.

Facts

During 2013 and 2014, American Express offered a rewards program wherein cash reward was paid to the credit card users who made eligible purchases on their American Express cards. The reward that a card user could claim was based on a percentage of the user’s eligible purchases. There was no limit on the amount of reward a card user could earn in a Year.

Mr. Anikeev had two American Express credit cards (Amex Cards). Using Amex cards, he purchased Visa Gift Cards from the local grocery stores and pharmacies. He then used the gift cards to purchase money orders. He deposited the money orders into his bank account, and the money so credited was used to pay the Amex credit card bills. Most of his spending from the Amex cards consisted of purchases of Visa gift cards.

Upon payment of monthly Amex card bills, Mr. Anikeev received the rewards of 1% or 5% of the total purchases. Both the cards were closed in 2014. On closure, he redeemed the rewards standing to his credit which American Express paid to him by cheque as a credit balance refund. He redeemed $ 36,200 in 2013 and $ 277,275 in 2014. He didn’t report any income from such rewards program in his tax return.

IRS Contentions

IRS proposed to tax Mr. Anikeev’s rewards points because he did not earn them by acquiring goods or service. The IRS’ position was that rewards generated without purchasing goods or services are taxable. Thus, rewards generated by purchase of gift cards and then the purchases of money orders, without the purchase of any goods or services, should be taxable.

Card-holder’s contentions

Mr. Anikeevs took the position that the rewards generated by the purchase of Visa gift cards are not taxable. He asserted that the manner in which something is purchased is not an accession to wealth. Further, he explained that the Visa gift card is a product that has a Universal Product Code and the ultimate use of the Visa gift cards should not matter.

United States Tax Court’s Ruling

The US tax court held that rebate provided to taxpayers on the purchase of property and services do not constitute income of the taxpayer. The Visa gift card provides a consumer service embodied in a simple plastic card for convenience. It is a product and thus, the reward received by Mr. Anikeev constitutes rebates excludible from taxable income. However, the money order and reloading cash into debit cards is nothing other than cash transfers. Thus, the reward received in connection with the direct purchase of these items did not constitute rebates and were includible as taxable income in the hands of Mr. Anikeev.

Implication under the Indian Income-tax Act

This ruling will have implications under the Income-tax Act as well. Various online shopping websites, credit card companies, and e-wallet companies offer lucrative reward schemes. These rewards are awarded either by way of ‘Instant Discounts’ or ‘Cash Backs’ or ‘Reward Points’.

Any monetary benefit received by a person by way of gifts or cash backs from a non-relative might be subject to income-tax under the head ‘Income from Other Sources’ or ‘Profits and Gains from Business or Profession’, as the case may be.

Before we evaluate the taxability of such benefit schemes, it would be imperative to first take cognizance of the provision of Section 56(2)(x) of the Income-tax Act. This provision provides for a levy of tax if any sum of money is received without consideration. This tax, popularly known as ‘gift tax’, is levied only if the aggregate value of such sum exceeds Rs 50,000 during the financial year. If the benefits are not given in the form of cashback but in the form of accessories (i.e., free earphones, power banks, etc.), this provision shall not be applicable. However, the market value of freebies can be taxable if goods are purchased for business or profession as all benefits, arising in the course of business or profession, are taxable under section 28(iv) whether they are convertible into money or not. In other words, the provision of gift tax can be invoked only if any monetary benefit is received by way of credit in the bank account, e-wallets or credit card. In the case of gifts received in kind, no amount is credited to the user’s account; hence, gift tax provision shall not be applicable.

The above ruling may open a pandora’s box of tax assessments and re-assessments in India. Rewards in the form of cashback or credit card points used to pay credit card bills or buy covered goods (jewellery, drawings, etc.) could be held taxable in India if the total amount of benefit exceeds Rs 50,000 during a financial year.