Target Group Ltd - Supreme Court judgment

Background

Shawbrook was in the business of making new loans to customers. As with many challenger banks, it did not develop a large in-house infrastructure required to manage the loans, but outsourced this business process, in its entirety, to Target. Target would, for example, set up direct debits, calculate payments due, process payments and deal with defaults, acting as undisclosed agent for Shawbrook. However, Target only managed the loans after they had been granted by Shawbrook without being involved in the loan origination. 

Target considered the wide range of services it supplied to constitute a single, complex supply of exempt payment processing services. However, HMRC disagreed, considering the composite supply to be taxable, in particular because Target’s role in the arranging of payments from borrowers to Shawbrook was limited to passing the relevant information to BACS, rather than making the legal and financial changes necessary to constitute an exempt payment transaction under item 1, Group 5, Schedule 9 VATA 1994 (the “Payment Exemption”).

Target lost at each stage of the litigation up to the Supreme Court as follows: 

• The First-tier Tribunal (“FTT”) concluded Target’s supplies would have fallen within the scope of the Payment Exemption, but were excluded as debt collection; 

• The Upper Tribunal (“UT”) did not consider Target’s supplies to come within the scope of the Payment Exemption at all, as its role was limited to passing information concerning the payment to BACS, which fell short of an exempt payment transaction. The UT also rejected Target’s alternative argument that its supplies were exempt under item 8, Group 5, Schedule 9 VATA 1994 (the “Current Account Exemption”), as the loan accounts operated by Target did not have the necessary features to qualify as current accounts (for example, enabling a customer to deposit/withdraw funds in varying amounts); and 

• The Court of Appeal (“CA”) agreed with the UT that merely passing information to BACS was insufficient for the payment exemption – suggesting that the earlier CA decision in FDR [2000] STC 672 (“FDR”) was no longer valid in light of CJEU decisions such as Case C-350/10 Nordea, Cases C-607/14 Bookit and C-130/15 NEC, and Case C-5/17 DPAS (“DPAS”). The CA also rejected Target’s arguments that its supplies constituted transactions concerning debts, and that its supplies fell within the scope of the Current Account Exemption.

 The Supreme Court’s decision

The Supreme Court has endorsed the CA’s conclusions, finding that: 

• The Payment Exemption must be read narrowly, in line with cases such as DPAS, as meaning that the services “must in themselves have the effect of transferring funds and changing the legal and financial situation… [in terms of] functional participation and performance. Causation is insufficient, however inevitable the consequences” (at [56]); 

• FDR is no longer good law (at [64]); 

• In Target’s case, its function was limited to passing the necessary information to BACS, to enable BACS to give the relevant instructions to the borrower’s bank and Shawbrook’s bank – this was merely causing the payments to be made without functionally making those payments, and without assuming responsibility or liability for achieving the payments (at [67], directly endorsing the CA’s conclusions at paras [98 to 101] of its decision); and 

• Target’s services also could not fall within the scope of the Current Account Exemption, given the FTT’s findings of fact that the loan accounts maintained by Target merely reflected “expected payments [which are] initially assumed to be made” (at [50] in the FTT decision), which meant that they were no more than ledgers recording the effects of payments, without entries in those ledgers themselves effecting those payments (at [75]).

 Wider implications

While not a surprising outcome, this Supreme Court decision provides final, binding precedent explicitly confirming that anything short of a supplier directly performing the legal and financial functions of materialising a transfer or payment is outside the scope of the Payment Exemption. 

While this decision brings some much-needed clarity to the scope of the Payment Exemption, from a practical perspective, it creates the prospect of it being much more difficult to support the exemption applying to supplies by any taxpayer outside the operation of clearing systems. The Supreme Court explicitly states at [58] that “in many cases this will mean that it is only the services provided by a bank or similar financial institution which will be exempt” (although it did point to Case C-464/12 ATP Pension Service A/S as an example of a different type of supplier who could benefit from exemption).

It would not be surprising if HMRC looked again at other businesses who rely on the Payment Exemption. Challenges where supplies fall short of the stringent conditions set out by the Supreme Court may be expected. Businesses reliant on the Payment Exemption, be that from a supplier or recipient perspective, should carefully review their position in light of this decision.

In particular, we expect that the following businesses may be affected:

• Merchant acquirers;
• Payment services providers;
• In-house payments entities;
• ATM operators; and
• Outsourced providers (including inter-company providers) to the above.