Target Group Ltd v. HMRC [2023] UKSC 35 (11 October 2023)

Facts

• Shawbrook Bank Limited ("Shawbrook") was in the business of making loans to customers. It outsourced the whole process of managing those loans to Target.
• Target's role included setting up direct debits, calculating the amounts of interest and principal repayments due, ensuring payments end up in the right loan account, issuing instructions to BACS and CHAPS to move funds between Shawbrook's bank accounts, and fixing issues arising from missed payments or arrears.
• Target submitted that it was providing a single and complex supply of VAT-exempt payment processing services to Shawbrook. However, HMRC considered that the exemption did not apply, as it only applies to the execution of an order for transfer or payment and not to giving instructions for payment.

Question asked to the SC

Do the services provided by Target to Shawbrook fall under the payment VAT exemption in Article 135(1) of Council Directive 2006/112/EC?

SC's decision

• Target did "cause" (or trigger) payments by sending instructions to BACS and CHAPS. However, that was not enough. Target should have been involved in the actual execution of the payment rather than in the "passing" of information to those schemes so as to be exempt from VAT.
• In addition, Target was not liable or responsible for the underlying execution of those payments as Target did not execute them.
• The fact that Target was performing various activities in relation to the loan accounts was not supportive either. This is because those tasks were no more than "ledgers recording" the effects of payments without entries in those ledgers themselves affecting those payments. 

Comments

The SC went for the narrowest option at the expense of FDR

Although the outcome of the judgment may not be surprising for some, as Target lost at every step of the appeal process, the tone of the SC's decision was perhaps stronger than expected. The SC vigorously held that a narrow interpretation of the exemption should prevail, considering CJEU cases on this matter, effectively subordinating the exemption to the actual execution or performance of the payment. In other words, the exemption applies to the final step of the payment lifecycle, and any step prior to the execution is not caught by the exemption, no matter how important a step might be.

We note that the SC did not engage at all with an alternative option consisting of departing from CJEU cases and endorsing a wider and more flexible interpretation that was decided in Customs and Excise Commissioners v. FDR Limited [2000] STC 672. This would have been possible under the European Union (Withdrawal) Act 2018.

What are the risks, and what actions can businesses take?

One of the key challenges for many businesses active in the payment sector will be to understand how the judgment should be read and applied in their context. If the judgment from the SC is applied strictly by HMRC, as one would expect, many businesses will inevitably have to grapple with the details of the judgment and assess how to apply the reasoning of the SC to their own set of facts. This is particularly acute for payment businesses that operate outside the traditional banking sector, e.g., PSPs, e-money, and in-house payment entities, as they are not involved in the interbank clearance process and have to "evidence" how involved they are in the actual payment execution.

We recommend that businesses active in the payment sector review their arrangements and assess whether those are likely to amount to payments under the test set out in the SC's decision in Target Group Ltd v. HMRC. If payments are being made, it is advisable for businesses to revisit their legal arrangements to ensure a clear contractual articulation of the payment execution as well as the supplier's liability in relation to the underlying payments. This will no doubt require collaboration between the business, legal, and tax teams.

Netherlands

In the Netherlands, case law that sees to the VAT treatment of "payment services" is in line with CJEU case law and confirms that the payment VAT exemption should be interpreted narrowly. On that basis, payment services will generally be VATable in the Netherlands unless they meet the "whole, specific, and essential" test given by the CJEU. In practice, the latter has proven to be the exception to the main rule.

However, there is a policy in place that dates back to 1983, in which the Dutch Ministry of Finance qualifies a list of different "banking services" as either taxable or exempt ("Banking Resolution"). Although certain VAT-exempt qualifications are not in harmony with later CJEU judgments, the Banking Resolution has not been revoked. Dutch tax courts confirmed that taxpayers can, in principle, still invoke the Banking Resolution until it has been revoked, which creates options to treat certain payment services as VAT-exempt.

Italy

In Italy, the Italian tax authority (ITA) tends to follow the principles and decisions of the CJEU regarding the VAT exemption of payment services. In this sense, the ITA has issued several rulings on VAT exemption related to payment services. According to the Principle of law No. 12/2019, the fees charged by a bank to commercial merchants for payments made by customers are exempt from VAT, pursuant to Article 10(1)(1) of Presidential Decree No. 633/1972 ("Italian VAT Decree"). In this regard, the ITA points out that these fees remunerate a service provided by the bank, which consists of the transfer of funds (in the form of electronic money) between the parties involved in these transactions.

Furthermore, it is interesting to mention Ruling No. 842/2021, where the ITA clarifies the VAT treatment of outsourcing of banking and finance services, as the authorities consider that online services can be ancillary to the banking services and, therefore, VAT exempt. In relation to home banking and mobile banking services, the "virtual banking" service is VAT exempt only if it is used exclusively to carry out transactions that are VAT exempt under Article 10 of the Italian VAT Decree. In addition, the "online functions" of the remote banking service that are different from the services ordinarily provided by the bank can be exempt from tax if there is an ancillary relationship between them, i.e., (i) online services, by enabling the dematerialisation, make possible the execution of the banking transactions requested by the customer and (ii) both transactions are rendered by a single party to the same customer recipient.

Target submitted that it was providing a single and complex supply of VAT-exempt payment processing services to Shawbrook.