The VAT treatment of payment processing services has been a subject of controversy and litigation. The main question is whether such services fall within the exemption for transactions concerning payments or transfers under Article 135(1)(d) of the Principal VAT Directive (PVD) and item 1 of Group 5 of Schedule 9 to the Value Added Tax Act 1994 (VATA).
Attempting to define what ‘transactions concerning payments’ means has resulted in 25 years of litigation culminating in the Supreme Court decision in Target at the end of 2023.
VAT exemption for payments timeline
1997 - SDC
The journey started in 1997 with the ECJ judgment in Sparekassernes Datacentre (‘SDC’ Case C-2/95). SDC provided outsourced services to German Banks that involved it entering debits and credits into client accounts. The ECJ held that such transactions were exempt only if they involved ‘a change in the legal and financial situation of the parties’.
2000 - FDR
FDR supplied credit card services to issuers and acquirers. FDR enabled the movement of money by instructing BACS to make transfers, it did not itself execute the transfer. The Court of Appeal ruled that the services were exempt as they had the automatic and inevitable effect of causing the transfer of money.
There was then a period of perceived certainty where it was accepted that the giving of an irrevocable instructions to cause a transfer was sufficient to qualify as an exempt transaction. The ‘causation’ approach that was established in FDR was followed by the courts in several cases in the following years.
2010 - Axa Denplan
Denplan operated a dental payment plan under which patients could pay a monthly fee for dental care. Denplan collected money from patients and passed it to the dentist. The CJEU held that the services were taxable as debt-collection but did indicate that they could have been exempt were it not for the debt collection exclusion.
2016 - Bookit II and NEC
Both Bookit and NEC charged card handling fees in relation to ticket sales. In both cases the taxpayer collected customer card details and sent an end of day settlement file which would trigger the payment. The CJEU concluded that the service consisted of a taxable exchange of information and the fact that the settlement file automatically triggered a payment did not alter this.
2018 - DPAS
DPAS concerned a similar dental plan to Axa Denplan but the contract had been restructured to make the patient the customer so as to avoid the debt collection exclusion. The CJEU concluded that DPAS did not qualify for exemption as it did not effect the legal and financial changes but asked the relevant financial institution to carry out the transfer.
2023 - Target
Target provided outsourced loan administration services to Shawbrook bank, including operating individual loan accounts and instigating and processing payments due from borrowers.
The Supreme court ruled that the exemption must have a narrow interpretation, as stated in SDC and clarified in DPAS, and that the services themselves must have the effect of transferring the funds and causing the change in legal and financial situation. Causation is insufficient, however inevitable the consequences. Therefore, ‘domestic law had taken a wrong turn’ in FDR in extending the exemption to the giving of instructions that trigger a transfer.
What now for the payments exemption?
The decision in Target has left many reconsidering the wording of the judgement in SDC and whether it is possible for businesses other than a clearing bank to be able to ‘change the legal and financial position’. It would appear to also follow that when these activities are outsourced by a clearing bank they can also qualify for exemption, as in SDC.
So, does this mean if FDR was heard again today it would be held to be taxable? Not necessarily, the UK legislation contains note 4, Group 5, Schedule 9, VAT Act 1994, which provides:
This Group includes any supply by a person carrying on a credit card, charge card or similar payment card operation made in connection with that operation to a person who accepts the card used in the operation when presented to him in payment for goods or services.
It is not clear which item of Group 5 this note refers to, but it would appear to extend the exemption to all parties involved in the card payment cycle, regardless of whether they meet the SDC test of changing the financial and legal position of the parties.
As the payments sector continues to adopt new technologies, we are seeing ever more ways of paying that don’t involve a physical card. These new payment processes can also result in many more participants in the supply chain. Does the exemption provided in note 4 extend to all of these providers, or do they each need to be able to demonstrate that they effected the legal and financial situation of the parties in the milliseconds that it takes to process a payment?
Whilst Target has brought a degree of clarity to what activities the exemption doesn’t apply to, it still leaves many questions unanswered, and one can’t help but feel that we still have many more years of litigation on this to come.
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