Tax

Modern payment methods and their VAT treatment: the European Union Court of Justice rules on the VAT financial services exemption in relation to transactions concerning payments and transfers (Case C-5/17, 25 July 2018)

Written on 14 Dec 2018

In its ruling on Case C-5/71 (HMRC Her Majesty's Revenue and Customs v DPAS Limited), the European Union Court of Justice (ECJ) confirms its interpretation regarding such exemption. Its applicability should be determined in accordance to the nature of the service provided, irrespective of whether or not the provider is a financial institution or a bank and irrespective of who the recipient of the service is. However, the ruling's restrictive interpretation of this exemption implies that, in practice, it may be increasingly more difficult for undertakings other that financial institutions to apply this exemption.

The ECJ started by analysing the facts that gave rise to the questions referred for a preliminary ruling by the Upper Tribunal of the United Kingdom. Specifically, in the case at hand, the plaintiff (DPAS), an entity managing dental plans, would request that a number of transfers be made. Firstly, via direct debit, DPAS would order the relevant financial institution to transfer a specific sum from the patient’s bank account to DPAS’s own account. Once received and after deducting a fee for its own services, DPAS would then order this money to be transferred from its account to the respective accounts of the insurer and the dentist.

In this context, the English Tax authorities maintained that a functional analysis of the services provided by DPAS led to the conclusion that DPAS, as a taxable person resorting to financial institutions to make transfers between accounts, does not carry out transfers within the meaning of the VAT exemption but rather only administrative tasks.

DPAS, on the other hand, DPAS understood that, in accordance with ruling C-175/09 in the AXA UK case, the service in question should be seen as a VAT-exempt transaction relating to payments. Moreover, the service did not amount debt collection (a service not covered by the exemption) as DPAS’ services were not provided to the creditor, but rather to the debtor (patient).

In relation to these points, the Upper Tribunal made a referral to the ECJ asking whether the financial transactions exemption under Article 135 of the EU VAT Directive should be interpreted as applying to transactions involving payments and transfers such as those carried out by DPAS.

The ECJ declared that:

  • For a transfer to be considered as a VAT-exempt financial operation, it should affect the existing legal and financial position of the parties concerned. For these purposes, these effects should be seen, on the one hand, in the relationship between the person ordering the transfer and the beneficiary of such transfer and, on the other hand, in the relationship between the aforementioned parties and their respective banks. This was not true of the case at hand.
  • Given that a bank transfer as such is only a means to deliver funds, the functional elements of a particular transaction involving a transfer were key in order to determine whether such transfer effectively amounts to a VAT-exempt service within the meaning of the Directive.
  • Additionally, it is necessary to distinguish exempt financial services from mere material, technical or administrative services. To that end, it is useful to analyse whether the responsibility of the provider is limited to administrative aspects or whether it extends to specific and essential elements of financial operations.

Based on the above, the ECJ concluded that, in this case, the provision of services was not included within the exemption of Article 135 of the EU Tax Directive given that DPS carried out purely administrative functions.

The ECJ also repeated certain principles of its case-law and made two fundamental points clear:

  1. The exemptions referred to in Article 135(1) of the EU Tax Directive are concepts specific to European Union law, intended to avoid inconsistencies between Member States in their application of the VAT system.
  2. The terms of such exemptions should be interpreted narrowly, since they constitute exceptions to the general principle that VAT is levied on each supply of goods and services for consideration carried out by a taxable person.

In conclusion, in order to determine how the exemption for financial services established in the VAT Directive should apply, it is necessary to examine the exact nature of the transaction and the extent of the liability of the supplier. This is independent of whether or not the supplier is a financial institution, a bank or of the recipient of the service and of who the recipient of the service finally is.

Increasingly, businesses that are not banks or traditional financial institutions are carrying out activities around payments and transfers. Such businesses facilitate payments or are to a certain degree involved in the money flow between clients and original service providers (for example payment apps or online payment or reservation platforms). In practice, it will not be easy to determine whether such activities entail changes in the legal and financial position of the parties and, therefore, whether a particular business model is subject to or exempt from VAT.

This judgment is relevant since it may constitute the starting point for the different Tax Authorities to analyse whether or not financial transactions fall within the scope of the exemption provided for in the European Directive, with a possible risk of inconsistent interpretations among different Member States.