In brief
The Supreme Court (SC) has unanimously dismissed the appeal of Target Group Limited (Target) against the Court of Appeal's decision that loan administration services Target provided to a bank (including operating loan accounts and processing payments from borrowers) were not exempt from VAT. The SC decided, in light of the Court of Justice of the European Union (CJEU) case law, that the payment VAT exemption should be interpreted "narrowly".
It held that, in order for the payment VAT exemption to apply, it is necessary to be involved in the actual execution of the transfer or payment, which requires a "functional participation and performance". It is not enough to give instructions to another party, even if it triggers a transfer or payment. Target was merely giving instructions.
The decision is relevant for all UK businesses that are active in the payment sector, from payment service providers (PSPs) and in-house payment entities to e-money and crypto providers and wider payment schemes.
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 Supreme Court
Do the services provided by Target to Shawbrook fall under the payment VAT exemption in Article 135(1) of Council Directive 2006/112/EC?
Supreme Court'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 since 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 effecting 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 since 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 in light of 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 as well in-house payment entities – since 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. 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.
