Background
Fintech innovation and the rise of e-payments are redefining traditional boundaries in financial services, exposing VAT frameworks that remain rooted in outdated legal principles.
Nearly three decades of decisions from the Court of Justice of the European Union (‘CJEU’) and UK courts highlight the ongoing ambiguity in applying VAT law to payment service providers (‘PSPs’) and other financial businesses. Central to this debate is whether their services constitute exempt “transactions concerning payments or transfers” or whether they fall within the excluded category of “debt collection” or perhaps constitute technical / administrative services, leaving them subject to VAT.
Current framework
Two key provisions govern the VAT treatment of services that are primarily designed to ensure a creditor receives payment.
Article 135(1)(d) of the EU VAT Directive (2006/112/EC) requires EU Member States to exempt transactions involving deposits, accounts, payments, transfers, debts, cheques and other negotiable instruments but expressly excludes “debt collection”. In effect, payment-related services are VAT-exempt unless they amount to “debt collection”.
In UK domestic law, these exemptions are set out in the UK VAT Act, Schedule 9, Group 5. Item 1 of this group exempts transactions involving money, securities, or payment instruments. Importantly, the UK VAT Act does not expressly exclude “debt collection” from these exemptions.
Relevant precedent
UK and European courts have spent the past 25 years refining the interpretation of Article 135(1)(d) to determine the precise boundaries of the payment transfer VAT-exemption.
The leading authority on this matter is Sparekassernes Datacenter (C-2/95) (‘SDC’), which established that to qualify for the exemption:
- the relevant services “must, viewed broadly, form a distinct whole, fulfilling in effect the specific, essential functions”;
- “the services provided must therefore have the effect of transferring funds and entail changes in the legal and financial situation”; and
- “a service exempt under the Directive must be distinguished from a mere physical or technical supply, such as making a data-handling system available to a bank… in particular the question whether its responsibility is restricted to technical aspects or whether it extended to the specific, essential aspects of the transaction”.
Subsequent CJEU rulings have refined these principles, progressively narrowing the scope of the VAT exemption under Article 135(1)(d).
AXA (C-175/09) confirmed that any services intended to obtain payment of monetary debts, even if timely, qualifies as “debt collection” and is subject to VAT under Article 135(1)(d).
Nordea Pankki Sumoi (C-350/10) (‘Nordea’) clarified the boundaries of Article 135(1)(d) by ruling that SWIFT international banking messaging services do not qualify as transactions concerning payments or transfers. The CJEU held that they were merely ancillary administrative / technical services that were subject to VAT.
While the CJEU initially interpreted Article 135(1)(d) narrowly, the UK Court of Appeal decision on 14 June 2006 Bookit Ltd was pivotal in broadening the scope for exemption. This case confirmed that processing card payments for advance cinema bookings qualifies as an exempt payment transaction under Article 13B(d)(3) of the Sixth Directive and Schedule 9, Group 5 of the VAT Act. However, this decision was overturned on 26 May 2016 when HMRC re-litigated the matter.
In 2023, the Supreme Court in Target Group Ltd reaffirmed a restrictive approach consistent with previous EU rulings. The case concerned a taxpayer providing loan administration services to a bank, which the Court held were VAT-able “debt-collection” services rather than VAT-exempt financial services.
Post-Brexit impact
As of 1 January 2024, the Retained EU Law (Renovation and Reform) Act 2023 abolished the principle of EU law supremacy in the United Kingdom. UK courts are now bound to interpret and apply domestic legislation without subordinating it to EU legal principles. This means that the EU VAT Directive (including Article 135(1)(d)) no longer has direct effect on UK taxpayers and the UK courts no longer have authority to disapply UK statutes on the grounds that they conflict with EU law.
Practical steps for businesses
While large PSPs and other fintech businesses generally face little resistance in securing VAT-exemption for their services, the ability to change the legal and financial situation of others in the UK arguably rests with the Bank of England. HMRC appears increasingly focused on challenging the application of the “debt collection” and “administrative / technical services” exclusions to smaller fintech firms, creating uncertainty for emerging payers in the market.
UK businesses have seen some notable wins, such as Paymex. On 26 May 2011 the First-tier Tribunal upheld Paymex’s appeal, ruling that its services constituted a single exempt supply of transactions concerning payments, falling under Article 135(1)(d) rather than taxable “debt collection”.
A further example of success is the First-tier tribunal case of EMPL. Initially, on 17 November 2015, HMRC held that the supplies made from EMPO (in Bulgaria) to EMPL (in the UK) were taxable and not exempt. EMPL appealed this decision on 9 September 2022. HMRC argued, relying on CSC Financial Services, that EMPL acted merely as a subcontractor performing administrative / technical services. This argument was rejected. The Tribunal held that the company’s activity of introducing merchants to PSPs under commission agreements qualified as exempt financial intermediation under Article 135(1)(d).
These decisions may seem promising for UK businesses seeking VAT-exemption under Article 135(1)(d), but they carry little weight as they are not binding precedent on other businesses performing similar services.
What is missing is a definitive UK ruling from a higher court (ie Upper Tribunal, Court of Appeal, or Supreme Court) relating to post-1 January 2024 transactions to create binding precedent, building on these taxpayer successes. In the absence of legislative clarity, businesses should strongly rebut any HMRC VAT assessments. Until then, growing fintech companies are at risk from a lack of binding UK case-law precedent in their favour but can perhaps mitigate the risk of HMRC challenge by securing insurance now to cover potential future HMRC VAT, interest and penalty assessments and associated HMRC litigation costs.
