VAT exemption for Loan Administration services

After nearly six years of legal arguments, the Supreme Court has made a final decision regarding Target Group Ltd.’s (“Target”) position that its loan administration services to a bank constituted a VAT-exempt supply of finance services. The Supreme Court has ruled that they do not. This decision overturns previous caselaw and could have a knock-on effect for many supplies made by various financial intermediary businesses as well as the financial institutions themselves as customers.

The basics

Under the UK rules, certain financial services are VAT exempt; these include:

• The issue, transfer, receipt or dealing with money
• Loan management services by the person granting the loan
• The operation of a current, deposit or savings account

The arguments

Target provides outsourced loan administration services to banks and building societies, including Shawbrook Bank. Shawbrook was a provider of a range of mortgages and loans. Given that Target was not the lender, it could not rely on the exemption under b) above.

Target did not provide any loan origination services to Shawbrook that are usually regarded as VAT exempt - such as finding potential borrowers, vetting loan applications, performing valuation checks, negotiating terms of lending, and arranging the execution of the loan.

From the First Tier Tribunal hearing onwards, Target’s basic argument was that the loan administration services provided to Shawbrook qualified for exemption as a financial service because it:

• Created a loan accounts, immediately after loan were made
• Operated the accounts and dealings with the customer up to the point of final repayment
• Matched payments to individual loan accounts and identified missing payments
• Generated the instructions for direct debit payments (a BACS file of electronic payment instructions to banks operating the borrowers' bank accounts)
• Calculated the amounts of interest and principal repayments due, and for calculating and applying any fees
• Dealt with any overpayments, missed payments and arrears

Therefore, its services were VAT exempt under the key exemptions (as set out in a) and c) above).

HMRC argued that Target's supplies were composite taxable supplies of ‘the management of loan accounts’. Alternatively, HMRC considered Target was providing taxable ‘debt collection’ services.

The Court judgments

At the earliest stage of this dispute, the First Tier Tribunal dismissed Target's appeal, holding that the loan administration services were debt collection services and therefore were not exempt. Target appealed against this decision to the Upper Tribunal.

The Upper Tribunal decided that, at a fundamental level, the exemption could not apply to the services Target provided. The court said merely providing BACs instructions or creating and maintaining Shawbrook’s loans account did not constitute an exempt financial transaction. Therefore, it was not necessary for the Upper Tribunal to consider the debt collection argument; the Upper Tribunal found against Target.

The Court of Appeal took a similar line when rejecting a further appeal by Target and ruled that the services supplied by Target to Shawbrook were not 'transactions concerning payments or transfers' despite there being some precedent UK caselaw (FDR Limited -Court of Appeal 2000 STC 672) for taking a wider approach to applying the exemption in cases where intermediaries were involved in the transaction.

The Supreme Court echoed this judgement and specifically stated that a much narrower approach to the application of the exemption must always apply as established in the Court of Justice of European Union (CJEU) ruling in DPAS (Case C-5/17), one of a number of CJEU rulings in this area advocating a ‘narrow’ approach.

The Supreme Court was clear in saying that it was overturning the earlier FDR judgment - it stated that the exemption should only apply where the provider is:

"...involved in the carrying out or execution of the transfer or payment – its "materialisation". This requires functional participation and performance. Causation [ie giving BACS instructions] is insufficient, however inevitable the consequences.”

The fundamental issue arising for Target was that they were administering loans that had already been created before their involvement. Moving away from the ‘wider’ approach adopted by the Court of Appeal in FDR, it decided that Target’s supplies were taxable.

Our views

Considering that the direction of recent case-law has moved towards narrow interpretation of the exemption, the outcome of this decision is not a surprise. However, this decision does not address the wider uncertainties in the VAT treatment for businesses who have alternative structures in place to service lenders in respect of the loan administration.

Whilst there is more clarity on the boundaries of exemption, it does raise the question of the extent to which this will increase inefficiencies and costs in a supply chain involving exempt financial services in the UK.

It is hoped that HMRC will now publish a formal Brief with guidance on how to apply the exemption in a range of scenarios. This includes clarifying whether they are planning to take any retrospective action for businesses relying on the wider interpretation of the exemption (using the FDR principles).>/p>

Implications for financial services businesses

Businesses in the financial services sector should consider the impact of the judgment in respect of their own operations.

• Loan administrators - There are a range of alternative arrangements in place for undertaking loan administration activities. Such businesses will need to revisit their arrangements to determine if the VAT position adopted is appropriate.
• Other financial institutions (including banks, Fintechs and payment services providers) - any business relying on a wider interpretation of the exemption to make or purchase exempt financial services needs to urgently review its VAT profile. This is particularly significant because the wider application of this disputed exemption has been refuted by the highest UK court.

Despite the clarity that the Supreme Court ruling brings, this remains a complex area of VAT so please contact Aditi Hyett or Stephen Kehoe for advice on your specific arrangements.