Unraveling the Hidden Costs of Cutting Interchange Fees on Sales Tax

Navigating the innovative yet challenging Illinois Interchange Fee Prohibition Act is no small feat for small business owners, financial analysts, and policy makers. This legislation bans interchange fees on the tax and gratuity portions of credit or debit transactions. In this episode, we'll unravel the complexities of the Act, detailing its provisions, the multifaceted challenges of its implementation, and the broader implications for the payment ecosystem.

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About the author:
Howard W. Herndon

Transcript

Welcome to Womble Perspectives, where we explore a wide range of topics, from the latest legal updates to industry trends to the business of law. Our team of lawyers, professionals and occasional outside guests will take you through the most pressing issues facing businesses today and provide practical and actionable advice to help you navigate the ever changing legal landscape. 

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Navigating the innovative yet challenging Illinois Interchange Fee Prohibition Act is no small feat for small business owners, financial analysts, and policy makers. This legislation bans interchange fees on the tax and gratuity portions of credit or debit transactions. In this episode, we'll unravel the complexities of the Act, detailing its provisions, the multifaceted challenges of its implementation, and the broader implications for the payment ecosystem.

Interchange fees are a crucial component of card payment transactions. These fees are charged by the card issuer to the merchant's bank and cover the costs of processing payments, mitigating fraud, and providing cardholder benefits. Interchange fees typically range from 1.6% to 3.25% or more, depending on the transaction type.

Merchants are already familiar with these fees, which significantly impact their bottom line. Historically, the debate over interchange fees on sales tax has revolved around fairness and transparency, with merchants arguing that it's unreasonable to pay fees on tax amounts that they merely pass on to the government.

The Act, soon to be signed into law by Governor J.B. Pritzker, prohibits the assessment of interchange fees on the tax and gratuity portions of a transaction. This groundbreaking legislation requires updates to technical specifications and systems to distinguish the core transaction amount from sales tax and gratuity.

Consider a small coffee shop in Chicago. Before the  Illinois Interchange Fee Prohibition Act, the shop paid interchange fees on the total sale, including tax. With the new law, the shop saves money on each transaction by not paying fees on the tax amount. However, merchants without updated point of sale systems must submit tax documentation to obtain credits for these fees, adding a layer of administrative burden.

Violating the Act comes with steep penalties. Merchants face a civil penalty of $1,000 per electronic payment transaction if they fail to comply. Additionally, issuers must refund interchange fees calculated on the tax or gratuity amounts, ensuring adherence to the new regulations.

The payment ecosystem comprises various participants, including merchants, payment processors, payment gateways, point of sale terminal vendors, card issuers, and financial institutions. Each entity must update their software, APIs, and transaction processing systems to comply with the  Illinois Interchange Fee Prohibition Act.

Implementing these updates is no small task. Technological upgrades across the entire payment ecosystem are required, with an estimated timeline of three to five years or longer. This includes modifying point of sale terminals, payment processing software, and other infrastructure components.

The financial burden of these technological upgrades is significant. Upgrading point of sale terminals in Illinois alone could cost over $43,750,000. The total cost of implementing these changes may range from hundreds of millions to upwards of a billion dollars or more, affecting stakeholders across the payment ecosystem.

The  Illinois Interchange Fee Prohibition Act faces potential antitrust and competition concerns from card issuers and payment networks. Existing contractual agreements could be disrupted, leading to a risk of legal battles as stakeholders challenge the new regulations.

The Act introduces new avenues for fraudulent activities. Without penalties for dishonest practices, merchants could exploit the system, misreporting sales tax amounts to avoid interchange fees. Fraudulent scenarios may arise, necessitating robust oversight and enforcement mechanisms.

The  Illinois Interchange Fee Prohibition Act has the potential to disrupt the established payment processing system. By altering the fee structure, it could create ripple effects across the industry, influencing how payment networks, processors, and merchants interact and conduct business.

Other states like Texas and Florida are considering similar regulations, and this Act could set a precedent, prompting a national trend towards eliminating interchange fees on sales tax. 

In sum, the Illinois Interchange Fee Prohibition Act  represents a significant step towards fairer merchant practices, but it also introduces complex challenges and costs. The shift would require stakeholders to adapt to new regulatory environments and prepare for further changes in the payment ecosystem.

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