United Kingdom: UK view on EU decisions - Will VAT become due on sub-participations?

In brief

In SKAS, the advocate general (AG) of the Court of Justice of the European Union (CJEU) held in his opinion dated May 2022 ("Opinion") that the service provided by the sub-participant to the originator did not amount to credit, thereby leaving the door open for VAT to be applied.

If followed by the CJEU, this Opinion could result in the originator incurring VAT on the sub-participation, which is unlikely to be recoverable. Unless the cost can be passed on the borrower, the economic benefit of such arrangements for the originator may be called into question. It is critical for businesses active in the sub-participation market to review their documentation and ensure they can support the application of the credit VAT exemption and distinguish themselves from SKAS.

The case is relevant for all businesses that have a presence in the EU, but also to UK clients that are active in the sub-participation market. The influence of CJEU decisions in this area remain of high relevance, and may impact the interpretation that UK courts give to the scope of the credit exemption under UK law post-Brexit in accordance with interpretative rules under the Withdrawal Act 2018.


C-250/21 Szef Krajowej Administracji Skarbowej (SKAS)

  • Investment fund A ("Sub-participant") pays Bank B ("Originator") an upfront amount upon conclusion of the sub-participation agreement.
  • In return for that payment, the originator, which has lent money to C ("Principal debtor"), agrees to pay the sub-participant the proceeds obtained under the original loan agreement with the principal debtor.
  • The loan receivables on which the sub-participation agreement is based remain the assets of the originator. The difference between the amount paid by the sub-participant to the originator and the amount obtained by the sub-participant in respect of the proceeds of the receivables constitutes the sub-participant's remuneration.
Question for consideration

Does the service provided by the sub-participant constitute granting credit, which is exempt from VAT as per Article 135 (1) (b) of the VAT Directive?

Advocate general's view

  • AG Medina considered that the sub-participant provides a service to the originator by providing liquidity and protection against the default risk associated with the underlying loans.
  • The AG explained that there are two fundamental and cumulative criteria for a sub-participation service to be VAT exempt as a granting of credit: i) capital and ii) receiving remuneration for making that capital available. The AG was satisfied that the amount received by the sub-participant is 'remuneration' for the provision of 'capital' to the originator.
  • However, the AG also pointed out that the amount received by the sub-participant may also be consideration for assuming the credit risk. Indeed, the AG argued that the purpose of the sub-participation agreement may be primarily for credit and capital risk management and that the VAT exemption should only apply where the provision of capital was the principal purpose of the agreement.
  • Here, the AG viewed the twofold purposes of the transaction as indivisible services such that neither could be regarded as principal or ancillary without verification by the referring court. By placing the credit and the risk management elements on an equal footing, the AG concludes that the service does not fall within the VAT exemption for the granting of credit.


Unexpected Opinion in a market that generally does not attract VAT

This Opinion may come as a surprise to many since it is widely accepted that the fees payable in the context of the sub-participation loan market do not attract VAT. The fact that the AG rejects the VAT exemption applicable to the granting of credit, whilst not clearly upholding that another VAT exemption applies, was an outcome not anticipated by the market participants and practitioners.

Although one element of sub-participations is to allow the originator to somewhat protect itself in the case of default of the principal debtor, the sub-participant's main role is to make an advance of money to the originator in return for consideration, arguably to free up capital. Nonetheless, the AG took the view that a key feature is the originator's transfer of credit risk to the sub-participant rather than the sole credit facility, so the transaction is not of credit. Perhaps this unexpected interpretation stems from legal documentation that the parties submitted before the court.

Whether the strict interpretation of the credit exemption put forward by the AG is a new jurisprudential trend is hard to tell. The most recent case law on the scope of the credit exemption (see Franck (C-801/19)) seemed positive as the court gave a broad scope to the VAT exemption. In SKAS, the AG seems to add an extra layer of complexity by focusing on the risk component, thereby calling into question the lighter approach shown by the CJEU so far.

What are the risks and what actions can businesses take?

If the CJEU upholds the Opinion, it is likely that any arrangements similar to the one in SKAS may result in VAT being due on the fees paid by the originator to the sub-participants. Although this could be beneficial for sub-participants since it would provide them with taxable income, the originators will on the other hand incur VAT, which is unlikely to be recoverable in most cases. This will hit their bottom line, and may carry the risk of putting pressure on the economic merits of such arrangements. One can anticipate that originators may try to push the cost down to the end borrower, although the mechanics and feasibility of such option will need to be carefully examined on a case-by-case basis.

We recommend that businesses active in sub-participations review their current documentation and assess whether their sub-participations are comparable to the facts in SKAS. It may be advisable for businesses to revisit their legal arrangements to ensure the clear predominance of the credit element over any risk management component. This will no doubt require collaboration between legal and tax teams and between the various parties involved in the sub-participation arrangements.

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