Supreme Court narrows UK VAT exemption for loan administration services

Target Group Ltd vs HMRC

Ajay Raval, Senior Manager, VAT and Customs Duty Services

The application of VAT exemptions remains a frequent area of dispute and a recent court decision continues the trend of the narrowing of the VAT exemption for payments and money transfers. The Supreme Court’s decision in Target Group Ltd. Target confirms that the VAT exemption only applies to services that carry out the specific and essential functions of a payment or transfer and excludes any services which are preparatory, ancillary, or administrative in nature.

Background

Target provided an outsourced service administering loans taken out by borrowers from Shawbrook Bank Ltd, a lender of mortgages and loans. The loan accounts maintained by Target were the sole record of the financial relationship between Shawbrook and its borrowers, serving as ledgers recording the level of indebtedness. Target provided Shawbrook with a range of services, including maintaining each borrower's account, instigating and processing payments from borrowers, calculating interest and fees, handling late payments and arrears, and managing early repayments and loan closures.

Target argued that its services were exempt from VAT under article 135(1)(d) of the Principal VAT Directive, which exempts "transactions, including negotiation, concerning deposit and current accounts, payments, transfers, debts, cheques and other negotiable instruments, but excluding debt collection".

Target’s appeal was rejected by the First-tier and Upper Tribunals. The Court of Appeal also upheld the previous decisions, holding that the decisive feature of a transaction concerning payment or transfer was the existence of a transaction consisting of the execution of an order for transfer of a sum of money, involving a change in the legal and financial situation between the relevant parties. Providing an indispensable constituent element to completing an exempt transaction was not enough. Actual execution was necessary to qualify as a transaction concerning transfer or payment; the mere giving of an instruction was not sufficient in itself, even if the instruction triggered an entirely automatic process leading to payment. It also held that the accounts operated by Target were not current accounts. Target then appealed to the Supreme Court.

The Supreme Court decision

The Supreme Court (SC) judges unanimously dismissed Target’s appeal and found that Target’s supplies were subject to VAT. Applying the CJEU case law, they held that the exemption only applies to transactions that have the effect of transferring funds and entail changes in the legal and financial situation of the parties. In the SC’s view Target's services did not meet this test as they did not involve the execution of an order for payment or transfer, but simply amounted to the giving of instructions to other financial institutions to do so.

Referring to the earlier decision of the CJEU in Sparekassernes Datacenter C-2/95 (SDC), the SC recognised that it was not completely clear whether a service constitutes a VAT exempt transfer of money if either:

it triggers an entirely automatic process leading to a transfer (“the wider interpretation”)
it must itself execute the transfer (“the narrow interpretation”).

The wider interpretation was adopted by the Court of Appeal in Customs and Excise Commissioners v FDR Ltd [2000] STC 672 (FDR) and was relied on by Target.

The court has concluded that subsequent CJ case law, in particular Bookit, NEC and DPAS made it clear that the narrow interpretation is the correct one.

The Supreme Court overruled the Court of Appeal’s earlier decision in FDR finding that it was based on an incorrect interpretation of the CJEU case law.

The Supreme Court also found that the making of entries by Target in the borrowers’ loan accounts did not result in any changes to the legal and financial situation between Shawbrook and the borrowers. The entries only reflected expected payments that were initially assumed to have been made and were recorded as such. Where a payment was not in fact made the entry was reversed. The loan account was no more than a ledger, recording the effect of payments made by customers to Shawbrook but not effecting such payments.

What this means for those facilitating payments

The Supreme Court's decision confirms that the VAT exemption for payments and transfers should be interpreted narrowly, and that it only applies to services that perform specific and essential functions of a payment or transfer, rather than services that are preparatory, ancillary, or administrative in nature. Suppliers and recipients of these services should consider how the decision will affect the VAT treatment of past or future transactions.

The decision on the payments exemption does not adversely impact cases where exemption can be obtained for the outsourcing of services to a financial intermediary acting in an intermediary capacity. Since the Court of Appeal's decision in EDS in 2003, HMRC's policy has been to distinguish between outsourced loan services where the service provider is involved in granting a loan and those where it is only involved in administration of existing loans. According to HMRC's current guidance, the latter closed book arrangements are taxable, whereas the former can be VAT-exempt.

As the Supreme Court is the highest in the UK, the litigation between the parties on this point is now at an end. Suppliers that have been relying on earlier case law should consider whether the approach they have adopted is correct in view of the law as it now stands.