Gift cards – gift or grief for the retailer? The answer depends on how much you know about gift cards. Gift card provide retailers with an opportunities to improve cash flows, increase sales and manage inventory. But more importantly, unredeemed gift cards have the potential to allow retailers to greatly improve their bottom line. Even so, gift cards can come with string attached, in the form of legislation and regulation. Therefore, here are of the things to consider as you ponder the contribution gift cards to your cash flow management strategy.
Nexus: Gift cards (other than electronic cards), are tangible representations of intangible property, but they are property none the less. Therefore, they have the potential to create economic nexus in a state where the issuing retailer does not have a physical presence. Therefore retailers who distribute gift cards through third parties could potentially be subject to multi-state income taxes.
State Escheat Laws: From time to time companies are left holding a liability for unclaimed or abandoned property held on behalf of the owner. Property is considered abandoned after a period of dormancy. The dormancy period as defined by states; escheat laws varies from state to state. Under the escheat laws the holders of abandoned property are required to remit the property to the applicable state which then holds the property in custody for the owners The dormancy period as defined by states; escheat laws varies from state to state. Under the escheat laws the holders of abandoned property are required to remit the property to the applicable state which then holds the property in custody for the owners. Approximately 10% to 19% of gift cards issued remains unredeemed, and may become subject to escheatment. Many states have increased their pursuit of abandoned property in efforts to increase revenues.
CARD ACT of 2009: The Credit Card Accountability, Responsibility and Disclosure Act of 2009, (CARD Act) took effect in early 2010. The CARD Act prohibits issuers from charging fees on cards for 12 months and extends gift card expiration date to five years after purchase. In addition to the CARD Act, gift cards are also subject to state statutes. Issuing retailers must become familiar with all applicable laws.
Accounting for Breakage Revenue: Retailers sell gift cards with an expectation of breakage revenue, (assuming that the state’s escheat rules do not apply). Breakage revenue is unmatched by cost of sales and can therefore, have a significant impact on the company’s financial statements. Although generally accepted accounting principles (“GAAP”), does not allow businesses to derecognize liabilities until the liability has been relieved, there is a special exception dealing with gift cards. GAAP allows companies to recognize breakage revenue when the chance redemption is remote, and it is possible to estimate the amount that will not be redeemed. However, GAAP does not prescribe and specific financial statement disclosures, how and when breakage revenue should recognized, or where breakage revenue should be recognized on the income statements. Fortunately the securities exchange commission, which is also an accounting standards setting body provides some guidance. Even so there is a lot of diversity among retailers on financial statement presentation of breakage revenue.
Federal Income Tax Deferral Period: Many retailers established separate gift card management companies in states with favorable escheat rules. While this may be an effective way to manage unclaimed property liabilities, it raises the questions: (i) which entity should recognize breakage revenue for income tax purposes and, (ii) assuming that the sale of gift cards is counted as income to the gift card company, which treasury regulation should be applied. The current treasury regulations allow one or two-year deferral base on specific conditions. To answer these questions, retailers and their advisors must understand Treasury Regulation 1.451-5 and Revenue Procedures 2011-18 and 2011-34.