In Target Group Ltd v HMRC [2023] UKSC 35 (“Target”), the United Kingdom’s Supreme Court has held that the loan services which the taxpayer company provided to a bank were not exempt from VAT.

In line with case law from the Court of Justice of the European Union (“CJEU”), the Supreme Court took a narrower interpretation than the UK’s higher courts had previously suggested when examining the scope of the UK’s VAT exemption for certain financial services.  The Supreme Court stated that, in order for the financial services VAT exemption which related to payments and transfers to apply, there had to be a “functional participation and performance”[1] within the transaction for which exemption is sought.  Target would have had to be involved in the actual execution of the transfer of payment; merely giving instructions on the transfer of payment was not enough for the VAT exemption to apply.

Background

Target was a provider of loan servicing to a lender bank. For each of the lender's borrowers, Target received loan information and created a "loan account". Target would then identify the loan balance, the repayment dates and the amounts (including interest) that should be applied to the next payment.  The services provided by Target included calculating fees, interest, and principal repayments due, providing instructions to the banker’s automated clearing system (known as “BACS”) and making ledger entries in loan accounts.  Target then liaised with borrowers to facilitate repayments and made binding instructions for funds to be transferred from the borrower to the lender.  These were all services relating to the loans made to the bank’s customers, and were accepted by the courts as being a single composite supply for VAT purposes.

Target’s Main Argument

Target argued that its services were exempt from VAT under the payments exemption 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”.[2]  These arguments were rejected by both of the UK’s tax tribunals, and by the Court of Appeal.  The principal issue before the Supreme Court was whether the instructions Target provided to BACS were within the scope of the exemption.

The Supreme Court followed the decision of the CJEU in Sparekassernes Datacenter v Skatteministeriet (Case C-2/95)("SDC")[3] which held that to fall within the scope of the VAT financial services exemption relating to payments and transfers, the services must have the effect of transferring funds and changing the “legal and financial situation” between the parties.   The narrow interpretation of SDC would be that the exempt services must in themselves have the effect of making changes in that legal and financial situation.  A wider interpretation of SDC would be that the VAT exemption would apply if the services have a mere causal effect, without changing the legal and financial situation between the parties in themselves.

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

The Supreme Court’s Decision

However, the Supreme Court rejected the wider interpretation of the Court of Appeal in FDR  on the basis that a causal link was insufficient.  Services which merely resulted in a payment being made were not VAT exempt services, even if the service was an indispensable part of the overall process of the payment being made. 

In order to rely on the VAT exemption for payments and transfers, the service must itself relate to a “functional participation and performance of the transfer”.[4]  Mere causation was not sufficient, regardless of how inevitable the consequences. 

Accordingly, services that are preparatory, ancillary or administrative in nature would not qualify for the exemption.

On Target in the Future?

The clarity of the Supreme Court’s judgement perhaps hides some of the difficulty identifying,  with precision, the nature of financial services which can clearly be identified as effecting a “legal and financial change”.  As electronic technology develops, the use of digital banking wallets, crypto-asset accounts and e-currency is likely to make the granular identification of the “functional participation and performance of the transfer” (and therefore the eligibility of services for VAT exemption) even harder.    

[1]       Target Group Ltd v HMRC [2023] UKSC 35 at paragraph 56.

[2]       Directive 2006/112/EC

[3]       Sparekassernes Datacenter v Skatteministeriet (Case C-2/95) [1997] BVC 509

[4]       Target Group Ltd v HMRC [2023] UKSC 35 at paragraph 56.