Is your financial services organisation within the payments exemption for VAT?

The recent case of Target Group Ltd v HMRC [2023] UKSC 35, heard by The Supreme Court, may impact the VAT position of a wide range of businesses offering certain payment services, financial technology solutions, or financial outsourcing and administration services. 

Case background 

This case considered the provision in EU law which exempts “transactions, including negotiation, concerning deposit and current accounts, payments, transfers, debts, cheques and other negotiable instruments, but excluding debt collection” from VAT (referred to as “the payments exemption”). The UK’s domestic implementation of this exemption was not considered in this case. 

Target Group administered loans on behalf of Shawbrook Bank which, amongst other things, provided mortgages and loans directly to customers. Target Group would manage the loan account ledgers maintained for each customer and relied on the payments exemption on the basis that it was facilitating payments from the customers’ bank accounts to Shawbrook’s bank account by issuing payment instructions which were automatically executed via the Bankers’ Automated Clearing System (BACS). HMRC contended that the exemption only applied to the execution of payments, with the giving of instructions merely being a preceding step distinct from actual execution. If HMRC’s argument was successful, the supplies made by Target Group would be taxable and their customers would pay VAT at 20% on their services.  

The Court of Appeal had agreed with HMRC’s reasoning. The Supreme Court case really focuses on the exact scope of the payments exemption with the core question being whether a business must directly execute payments or whether the initial instigation of the payment, leading to its inevitable execution, was sufficient to fall within the exemption. 

Analysis of recent cases 

There are three main cases in this area that must be considered here. Sparekassernes Datacenter v Skatteministeriet (Case C-2/95) (SDC) was the first case in the Court of Justice of the European Union (CJEU) considering the payments exemption. The decision establishes that, to benefit from the exemption, services must both have the effect of transferring funds and also change the legal and financial situation between the parties and/or their respective banks. The decision has however given rise to some debate as, due to being expressed in general terms, it has remained unclear whether the services provided had to in and of themselves effect the transfer and change the legal and financial situation (the “narrow interpretation”) or if it was sufficient for the services to inevitably cause the transfer and change (the “wider interpretation”). 

The main UK case considering the exemption was Customs and Excise Comrs v FDR Limited [2000] STC 672 (FDR), which involved a company providing credit card services to various banks and enabling the transfer of money between parties by instigating automatic BACS payments. The Court of Appeal, in an attempt to interpret SDC, held that it was sufficient if the services had the automatic or inevitable outcome of the transfer being executed. The UK courts have therefore, following FDR, generally endorsed the wider interpretation of SDC.

A string of CJEU cases subsequently began to cast doubt on the wider interpretation endorsed in FDR. This culminated in HMRC v DPAS Ltd (Case C-5/17) (DPAS) which confirmed the narrow interpretation of SDC. This CJEU case therefore, directly and explicitly, underlined that the UK courts had gone off course and deviated from the CJEU jurisprudence. 

What did The Supreme Court conclude? 

Having, broadly, undertaken the above analysis, The Supreme Court in Target Group Ltd confirmed the approach in DPAS and reiterated the continuing relevance of SDC. As summarised in the leading judgment: “It is necessary to be involved in the carrying out or execution of the transfer or payment – its “materialisation”. This requires functional participation and performance. Causation is insufficient, however inevitable the consequences.” In other words, while Target Group initiated the steps that lead to the execution of the transfer, it did not itself execute the transfer. The services did not, effectively, go beyond the transmission of information to another party for that other party to execute the transfer and, as a result, did not fall within the exemption. 

On Target Group’s alternative argument, that the recording of accounting entries on the borrowers’ loan accounts legally effected the payment or transfer, The Supreme Court firmly disagreed and noted that the loan accounts in this case were solely ledgers to record transfers expected to be made, which did not in themselves trigger any transfers of ownership. 

What does this mean for you? 

The wider interpretation endorsed by the Court of Appeal in FDR has been adopted in several subsequent UK cases and we are aware that some businesses continue to rely on these authorities. However, based on The Supreme Court’s decision in Target Group Ltd, the UK courts took a wrong turn and any businesses that have placed reliance on FDR will need to reassess their VAT exposure going forward.

What do you have to do to fall within the exemption?

It appears from the judgment that it is primarily the services provided by a bank or similar financial institution that will qualify for this particular exemption. Having said that, the courts have continuously asserted that the exemption is not limited to banks and financial institutions, but there is a lack of clarity as to what other types of services or businesses will fall within the exemption.

The decision in Target Group Ltd is most decisive in confirming what cannot, as opposed to what can, fall within the exemption. Importantly, financial services have become increasingly automated since the decision in SDC. While it is clear that a business can make fully automated supplies, the extent to which automated and back-office services can fall within the exemption will need to be examined. The UK courts will likely need to address these various points in future cases and will similarly need to engage with the various other exemptions which can apply to financial services.

As such, while this decision is insightful, it does not provide a framework for the types of services and businesses that are likely to fall within the exemption. In the absence of clarity on this point, it is important that businesses seek appropriate professional advice to ascertain whether their supplies are taxable or exempt. In this connection, please do not hesitate to contact our VAT team to explore how we can help you navigate this complex area.