I’ve written a couple of articles about Groupon on my sister blog, Canadian Restaurateur. This is part of a series that will cover accounting for Groupon certificates, setting up your Point of Sale (POS) system to properly track coupons and discounts, using QuickBooks to enter Groupon transactions, examining the tax treatment of Groupon certificates (this one), and finally, determining whether your restaurant should consider Groupon.
Note that this article is written from a Canadian perspective. Accordingly, I will only consider the GST/HST (Good or Harmonized Sales Tax) and income taxes related to Groupon certificates. Sales and income taxes in other jurisdictions may not treat Groupon certificates in the same way. If you are in doubt, please contact your tax advisor to confirm the proper treatment for your restaurant.
What are Groupon Certificates?
Groupon is a company that sells certificates that offer deep-discount deals. Usually, the purchaser is entitled to receive at least a 50% discount from the retail or menu prices charged by the restaurant. Essentially, they are gift certificates with a value of up to the face value of the certificate. Customers pay about 50% of the face value for the certificate, which we call the promotional value.
Groupon is responsible for selling the certificates and collecting the proceeds. By placing the deal on its website, Groupon provides the restaurant with “exposure” to a large number of potential customers. In return, Groupon charges the restaurant a fee, which varies and is negotiable. While the fee has usually been about 50% of the amount the customer pays for the certificate, I understand that competition has driven this percentage down to about 33% in some markets. Still, it’s a hefty price to pay!
Under the Excise Tax Act (ETA), the tax treatment of gift certificates is covered in s.181.2. Essentially, the sale of gift certificates is not considered to be a taxable “supply” (sale), and when they are redeemed, they are considered to be like money. Since the term “gift certificate” is not defined in the ETA, the CRA issued a Policy Statement (P-202) to clarify the types of certificates and coupons that are considered to be “gift certificates”.
The Policy Statement, provides several tests to determine whether a coupon is to be considered a gift certificate. In the case of Groupon certificates, it is clear that they are, in fact, considered “gift certificates”. Consequently, s.181.2 of the ETA applies and the sale of gift certificates is not taxable. Tthe restaurant sells these certificates at a discount to Groupon, who sells them to consumers and charges a fee for doing so. The customer is not charged HST on the purchase, as any sale of gift certificates is not taxable.
Drawing on a previous example, the customer buys a certificate that can be redeemed for $100 of meals and drinks. She pays only $50 for the certificate. Groupon charges the restaurant $25 for marketing the certificate. Note that the Groupon fee is a taxable supply of services to the restaurant. Accordingly, Groupon has to charge the restaurant $3.25 (13% HST) on top of their $25 fee. Groupon collects its fee from the proceeds from selling the certificate and remits the balance to the restaurant ($50 – $25 – $3.25 = $21.75).
The restaurant will be able to claim the $3.25 HST paid to Groupon as an input tax credit when it files its next HST return.
Now, customers go to the restaurant and redeem their certificates for food and drink. Under the ETA s.181.2, the restaurant is required to charge HST on the promotional value of the certificate. In our example, this is the $50 that was paid by the customer to Groupon, even though the restaurant did not actually receive this amount in cash. Note that the restaurant did receive consideration of $50. It got $21.75 in cash, a $3.25 HST input tax credit (recoverable from the CRA), and it received $25 of deductible promotional services from Groupon.
Restaurants will need to set up their POS systems to ensure that tax is only collected on the promotional value of the certificate. This will require setting up a discount to record a discount that brings the amount charged down to the promotional value. If the customer spends at least the face value of the certificate, the discount will equal the amount that the certificate was originally discounted. In our case $50 ($100 – $50). If the customer spends less than the face value, say $75, the discount to be applied will only be $25, leaving a $50 taxable amount on the guest check.
If the POS is set up, incorrectly, to deduct the face value of the certificate as a discount, in most cases, the guest check would not calculate HST on that amount. The restaurant would still be responsible for paying the HST that should have been collected on the promotional amount, plus penalties and interest.
If the POS is set up, incorrectly, to deduct the face value of the certificate as if it were “money”, the guest check would calculate HST on the menu items at regular prices. The customer would be over-charged HST, and the owner thinks he can pocket the difference. Uh, no. If the restaurant collects more HST than was required, the excess amount must be remitted to the CRA as additional tax. It was a nice try, though.
Income Tax Implications
So far, we’ve only been concerned with the HST implications. Now, let’s look at the income tax effects of Groupon transactions.
Note that the sale of gift certificates is not taxable for income tax purposes, just as it wasn’t taxable for HST. Instead, the entry to record the distribution of certificates sets up a liability for outstanding certificates. This is the value of meals and drinks that the restaurant has promised to provide to coupon holders prior to the expiry of the certificates.
Recall that the restaurant received $21.75 cash and paid Groupon $28.25 (including HST of $3.25), representing $50 or 50% of the face value of a coupon. The restaurant can claim the $3.25 as an input tax credit, and it can deduct the $25 fee paid to Groupon as a promotion or marketing expense. The total of these is $50. What about the difference between this $50 and the $100 face value?
That difference represents an expense, but it hasn’t been incurred just yet. It will be incurred as each certificate is redeemed by customers. So, we set up a deferred promotional expense as a current asset. As each certificate is redeemed, $50 of this amount is transferred from the deferred account to the promotion expense account. If all certificates are redeemed, the total promotional expense will be $50/certificate and $25 Groupon fee/certificate.
If 100 certificates had been issued and they were all redeemed, the restaurant would show $7,500 promotional expense on the income statement. What about the sales amount?
The best practice is to record sales at full menu prices (before discounts). In this case, if every customer purchased $100 and used a $100 certificate, sales would be $10,000 and promotional expenses would be $7,500. Here, we’re just considering the Groupon related expenses. Of course, cost of sales would go up along with other variable expenses. In this case, the restaurant made a “profit” (before variable expenses) of $2,500.
What if not all of the certificates are redeemed before the expiry date? In this case, the liability for remaining certificates is eliminated along with the remaining balance of the deferred promotional expense account. The net credit is deducted from the promotional expense as a recovery of promotional expenses. This increases the “profit” on the Groupon transactions.
Some restaurants fail to record the gross amount of sales (full menu prices) in the accounts. Instead, they record the sales net of discounts. From a tax point of view, this is a bad practice, because when the restaurant is audited, the auditor will be estimating the restaurant’s gross sales and comparing it with the sales reported by the restaurant in tax returns. To make the proper comparison, the restaurant will have to prove the amount of discounts related to the Groupon transactions and show how much related to liquor, wine, beer and draft.
Restaurants who follow this practice will need to maintain a meticulous file of guest checks and Groupon certificates that shows which items were discounted. Depending on how the POS system shows the discounts and the type of reports available, you may need to have a copy of the guest check before the Groupon discount and another copy with the discount applied, together with the actual coupon! Of course, these will have to be summarized, too. A
big HUGE, needless headache.