News and Insights

North Carolina Department of Revenue Rules on Applicability of Bad Debt Deductions to Private Label Credit Card Transactions

Tax Development Feb 21, 2011

The North Carolina Department of Revenue (“Department”) issued a Final Agency Decision holding that a retailer cannot take a sales tax bad debt deduction on private label credit card sales that become worthless. At issue was whether a retailer who contracted with third-party banks to administer a private label card program qualified for a sales tax bad debt deduction under Section 105-164.13(15) of the North Carolina General Statutes. The Department’s recent decision affirmed a prior administrative law judge’s decision that denied a bad debt deduction and request for a refund.

In a private label credit card transaction, a retailer and a card-issuing bank enter into an agreement whereby the bank offers a credit card to the retailer’s customers for use only at the retailer’s place of business. The bank charges the retailer a service fee to administer the private label credit card program. At the point of sale, the retailer accepts the credit card as payment for the goods purchased. The retailer then remits the applicable sales tax to the state. The bank pays the retailer for the goods sold using the card, including the applicable sales tax less the amount of the service fee. If the accounts become worthless, the bank, not the retailer is the party to write-off the account as worthless for federal income tax purposes.

In making its decision, the Department noted that the retailer could not write-off the accounts as worthless for federal income tax purposes because the accounts were held by the third-party banks, not by the retailer. The Department stated that Section 105-164.13(15) requires that the party taking the deduction must be both the party responsible to pay the tax and the party to write-off the account for federal income tax purposes. Therefore, the retailer did not qualify for the deduction.

In support of the deduction, the retailer argued that it acted as a “unit” with the third-party banks. As a “unit” with the banks, the retailer could be deemed to have taken the appropriate deductions. The Department rejected this assertion, holding that the unitary argument lacked merit because the retailer and banks did not act with “any singularity of purpose.” In the alternative, the retailer asserted that because it wrote-off its service fees for federal income tax purposes and those fees are intended in part to compensate the banks for any worthless accounts, it met the requirements needed to take the bad debt deduction. The Department dismissed this argument, concluding that service fees represent a business expense, not a bad debt for federal income tax purposes. The Department also noted that the third-party banks are not eligible to take bad debt deductions because such banks were not responsible for remitting sales tax to the Department on the original sales.


Douglas J. DeRito