VAT exemption for loan administration services

UK Supreme Court favours a narrow test for outsourced services to qualify for the financial services VAT exemption.

The VAT finance exemption (in Article 135(1)(d) of Council Directive 2006/112/EC, reflected in UK law in Group 5 of Schedule 9 to VATA 1994) provides an exemption for payment services (but excludes debt collection).

Target Group Ltd’s (Target) contended that its services to Shawbrook Bank Limited (Shawbrook), which included administering loans made by Shawbrook, operating loan accounts, and instigating and processing payments from borrowers, were VAT exempt because:

1. target gave instructions which automatically and inevitably resulted in the transfer of funds from the bank account of a borrower to the bank account of Shawbrook via the banker’s automated clearing system (BACS); and

2. target inputted the entries into borrowers’ loan accounts with Shawbrook which changed the legal and financial situation between Shawbrook and the borrowers.

The UKSC followed CJEU jurisprudence in SDC (C-2/95) and DPAS Limited (C-5/17) and held that the finance exemption should be interpreted narrowly, and not in accordance with Court of Appeal’s decision in FDR (2000 EWCA Civ 216) where it was interpreted widely. It concluded that to be exempt, the services must in themselves have the effect of transferring funds and change the parties’ legal and financial situation. It is necessary to be involved in execution of the transfer or payment – its “materialisation” – and it is not enough to give instructions to trigger a transfer or payment (i.e., causal effect is insufficient; functional participation and performance of the transfer is required). Further, inputting entries into borrower’s loan account was held to be no more than a ledger entry of “expected payments” which cannot affect a payment or result in a change in the legal position of parties. In many cases, this would mean that it is only services provided by a bank or similar financial institutions which will be exempt, but the UKSC held that that is not necessary as illustrated in the case of ATP PensionService (C-464/12).

Since Target’s services did not meet this criterion, UKSC unanimously decided that Target’s services were not VAT-exempt.

Key takeaway

The UKSC reaffirms that the VAT finance exemption is to be interpreted strictly. Businesses supplying or receiving payment services and treating them as VAT exempt must carefully review their VAT position in light of the narrow scope of the exemption illustrated in this case.