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Background

In this post, Mark Whiteside, Partner at CMS, and Johanna Dodgson, Associate at CMS, comment on the Supreme Court’s judgment in Target Group Ltd v Commissions for His Majesty’s Revenue and Customs [2023] UKSC 35.

Shawbrook Bank Limited (“Shawbrook”) is a provider of mortgages and loans. The appellant Target Group Ltd (“Target”) administers loans made by Shawbrook, including by operating individual loan accounts and instigating and processing payments due from borrowers.

The principal issue was whether the services provided by Target qualified for exemption under the Value Added Tax Act 1994, Group 5, items 1, 2, 2A and 8 of Schedule 9. It was not in dispute that the UK legislation reflects the exemption provided for in the Principle VAT Directive, Article 135(1)(d), for transactions, including negotiation, concerning deposit and current accounts, payments, transfers, debts, cheques and other negotiable instruments, but excluding debt collection.

Target argued that its services were exempt from VAT under the Principal VAT Directive, article 135(1)(d) (the payments exemption). Target relied on the fact that it procured payments from borrowers’ bank accounts to Shawbrook’s bank accounts by giving instructions for payment which were then automatically and inevitably carried out through the BACS system. Target also relied on the fact that it inputted entries into the borrowers’ loan accounts with Shawbrook, which it claimed amounted to transactions concerning debts.

Through the courts

The First-tier Tax Tribunal (“FTT”) found that Target’s supply included transactions concerning payments or transfers within the financial services exemption but that the predominant nature of the supply was debt collection, therefore excluded from the exemption and taxable.

The FTT decision was handed down before the CJEU decision  in Commissioners for Her Majesty’s Revenue and Customs v DPAS Limited (Case C-5/17) [2018] STC 1615 (“DPAS”) and when the case was appealed to the Upper Tribunal (“UT”), the UT held that the subsequent CJEU decision made it clear that the supplies by Target did not fall within the scope of the exemption for payments and transfers. The UT also held that Target’s inputting of accounting entries in the loan account did not fall within the exemption as it did not change any party’s legal and financial position.

Target appealed to the Court of Appeal. The Court of Appeal, unanimously, dismissed the appeal. In particular, DPAS made it clear that:

“actual execution is necessary to qualify as a transaction concerning transfer or payment, and the mere giving of an instruction is not sufficient in itself, even if the instruction is or order is indispensable to the transaction taking effect, and even if the instruction triggers an entirely automatic process leading to payment.”

In agreement with the lower tribunals, the Court of Appeal also rejected the alternative argument that the supplies were exempt as transactions concerning current accounts. In agreement with the FTT and the UT, the Court of Appeal considered that a fundamental characteristic of a current account was that a customer is able to deposit and withdraw funds in varying amounts and, in the case of a current account, the account holder can pay amounts to third parties. The loan accounts operated by Target were not “current accounts“.

Target appealed to the Supreme Court.

The Supreme Court’s judgment

The Supreme Court considered whether the instructions Target provided to BACS, which automatically and inevitably resulted in the transfer of funds from the bank account of a borrower to the bank account of the lender, meant that the services supplied by Target were within the scope of the exemption.

The Supreme Court considered the Court of Justice decision in Sparekassernes Datacenter v Skatteministeriet (Case C-2/95) [1997] (“SDC”). This was the first case to consider the exemption in the Principal VAT Directive, Article 135(1)(d). The Supreme Court derived the following principle from SDC: to be exempt the services provided by a data-handling centre, viewed broadly and ‘as a distinct whole’, must (i) have the effect of transferring funds; and (ii) change the legal and financial situation.

HMRC and Target disagreed about whether the reasoning in SDC required Target’s services to have this effect and make that change (‘the narrow interpretation’) or whether it was sufficient for them to have that causal effect (‘the wider interpretation’). HMRC argued for the narrow interpretation and Target for the wider.

Surveying the subsequent case law, the Supreme Court held that ‘later CJEU case law, and in particular Bookit Ltd v Revenue and Customs Comrs (Case C-607/14) [2016], National Exhibition Centre Ltd v Revenue and Customs Comrs (Case C-130/15) [2016] STC 2132  and especially DPAS, have made it absolutely clear that the narrow interpretation is the correct one.’

The narrow interpretation meant that in order to fall within the exemption:

  • the services must in themselves have the effect of transferring funds and changing the legal and financial situation;
  • it is not enough to give instructions to do so thereby triggering a transfer or payment;
  • it is not enough to perform a service which is essential to the carrying out of the transfer or payment, nor one which automatically and inevitably leads to transfer or payment; and
  • 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.

Based on the narrow interpretation, it was clear that Target’s services of providing instructions which automatically and inevitably resulted in payment from the borrowers’ bank accounts to the lender via BACS were insufficient to fall within the exemption.

Concluding thoughts

The Supreme Court’s judgment confirms that the VAT exemption for payments and transfers is to be interpreted strictly, and that it only applies to services that perform the specific and essential functions of a payment or transfer, not to services that are preparatory, ancillary or administrative in nature.