26th October 2023
‘Target’ decision means payment businesses may not meet the conditions for VAT exemption.
The Supreme Court has issued its decision in the “Target Group Ltd (‘Target’) v HMRC” VAT case, which considered whether supplies made by Target qualified for VAT exemption. The Supreme Court found in HMRC’s favour that the conditions for the exemption were not met.
This decision means it will be harder for businesses involved in the processing of payments to treat supplies as exempt. We now expect to see HMRC looking at businesses providing payment services and challenging whether VAT should be charged.
This will impact businesses within the financial services sector, including merchant acquirers; payment services providers; in-house payment entities; ATM operators and outsource providers to such businesses.
Shawbrook Bank Limited (‘Shawbrook’) provides loans and mortgages to its customers. It is supported in administering these products by Target, which provides a number of services to Shawbrook. Target, however, is not involved in loan origination, or the direct processing of any payments itself. The right to negotiate any changes to the loan terms remained the sole preserve of Shawbrook.
Target treated its services as exempt, as it considered these as being within the definition of Article 135(1)(d) of the EU VAT Directive: “transactions, including negotiation, concerning deposit and current accounts, payments, transfers, debts, cheques and other negotiable instruments, but excluding debt collection”.
HMRC challenged Target’s application of the VAT exemption. EU case law, regarding Article 135(1)(d), made clear that it only applies in respect of actually executing an order for the transfer of funds or a payment. HMRC considered that Target’s activities only amounted to issuing instructions for payment, merely being a preparatory step to executing an order. The services were not part of the process of execution and so fell outside the exemption, meaning they were subject to UK VAT at the standard rate (20%).
Target’s argument was that it fulfilled the VAT Directive’s requirements, due to its instructions inevitably resulting in Shawbrook receiving payment from borrowers via bank transfer (the “payments issue”). It also considered that the entries it made in the borrower’s loan account with Shawbrook caused the relationship between lender and borrower to change (the “Loan accounts issue”), and so qualified for application of the exemption.
The First-tier Tribunal found in favour of HMRC, determining that Target’s supply was principally of debt collection services, which are specifically excluded from the VAT exemption.
The Upper Tribunal likewise found in HMRC’s favour, relying on the Court of Justice of the European Union’s (CJEU’s) decision in the 2018 HMRC vs DPAS case (Denplan) finding that Target’s activities were indistinguishable to that of DPAS in the circumstances presented.
This Upper Tribunal decision was upheld by the Court of Appeal, and Target was granted permission to appeal to the Supreme Court.
The Supreme Court
The Supreme Court held that where financial service providers, such as Target, issue instructions to an entity for a payment to be made, it cannot be making an exempt supply. Even if such instructions are a prerequisite for payment, the VAT-exempt supply would be provided by the entity directly transferring the funds from account to account, usually (but not necessarily) a bank or financial institution. The “payments issue” argument made by Target was thus found to fail.
The Supreme Court reiterated the long-standing principle that VAT exemption must be read narrowly. The exemption can only apply to transactions consisting of the execution of an order for the transfer of money from one bank account to another – being characterised by a change in the legal and financial situation of the parties involved. Supplies not involving such changes fail to fall within that concept.
The Supreme Court also determined that Target’s accounting entries in the loan accounts and records likewise did not fall within the VAT exemption, as these did not result in a real change to either party’s legal and financial position.
Consequently, Target’s appeal failed, and its supplies were taxable to standard rate UK VAT.
HMRC is likely to carry out reviews of the activities performed by a range of payment companies which currently rely on the Article 135(1)(d) payment exemption. It will look to identify whether these are truly changing the relationships between counterparties under a narrow reading of the Article, with a view to raising assessments if they find the relevant conditions are not met.
If you have any questions on this matter, or suspect your business may be impacted by these developments, please reach out to our VAT Team, who are on hand to support, via VAT@haysmacintyre.com.