On January 16, 2020, the Supreme Court of Washington, in an en banc decision, held that a retailer was entitled to take bad debt deductions for sales and Business and Occupation (“B&O”) taxes when its customers defaulted on purchases made using private label credit cards.
The retailer contracted with banks to offer private label credit cards to the retailer’s customers. The banks offered credit to cardholders who purchased the retailer’s goods. After the purchases, the banks would send the full payments and sales tax to the retailer, which would then remit the sales tax to the Department of Revenue. The retailer agreed to reimburse the banks for losses they sustained on defaulting customer accounts, up to a 7% cap. In such instances, the retailer claimed bad debt deductions on its federal income tax returns, and sought refunds of sales and B&O taxes from the Department.
The court rejected the Department’s argument that the retailer is not entitled to the deductions because it fully recovered the sales tax funds from the banks and incurred no bad debt. The court reasoned that the retailer was entitled to take the bad debt deduction on the sales tax because it: (1) was the retail seller; (2) remitted the sales tax to the Department; and (3) was the guarantor of the unpaid sales tax. Even though the banks fully paid the retailer, the retailer did not receive payment from the defaulting buyers, and the retailer was the guarantor to the banks for the unpaid sales tax. The court concluded that it was irrelevant that the bad debt was created in two steps rather than one; the policy behind the bad debt deduction was to provide relief to vendors left holding uncollectible sales tax, including the retailer. For the same reasons, the court also determined that the retailer had incurred bad debt and was entitled to a bad debt deduction for B&O tax purposes.