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Monday, 15th April 2024
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Financial services and VAT Back  
A major VAT case involving outsourcing in the Financial Services industry is due to go to the House of Lords in the UK. The outcome will be significant for the economic viability of outsourcing.
Outsourcing can be important as a means of achieving cost reductions and improved quality of service. Often a specialist service provider can operate in certain niche areas more efficiently than a global financial service group.

A company called FDR in the UK is such an outsourcing company. It is the subject matter of a major VAT case on whether the services it supplies to several credit card companies/banks are exempt from VAT, or attract VAT. To date it has been held by the courts to be largely exempt. This position is being challenged by the Revenue in the House of Lords currently.

If the Revenue were to win this case FDR might have to charge VAT. Its customers (to a large extent supplying exempt services) would not be able to fully recover that VAT. FDR could be placed at a cost disadvantage compared to a situation where its customers carry out the work using their own staff and facilities.

If the EU ever succeed in coming up with a workable system of applying VAT to global money movements and hence make financial services transactions VATable, the FDR case will lose its significance. In the meantime it is an important case for financial services companies.

The FDR case
The FDR case is not authority for the proposition that all outsourcing by financial institutions attracts the same exemptions as are available to the financial institutions. All it is authority for is that the extent of the outsourcing that occurred in this case meant that FDR were carrying on transactions that were exempt by reason of being the service of making transfers of money.
FDR handled the entire credit card function of a number of institutions. It issued cards, it authorised transactions with merchants, and it kept the records of card-users liabilities, and amounts owing to merchants. It also issued the instructions upon which other clearinghouses made the necessary credits to merchant’s bank accounts. It acted as a clearinghouse as between the various banks necessarily involved in the transactions (banks acting for the merchants, and the banks who act as credit card companies). It would collect net sums of cash from some banks, and make net payments over to other banks, as the flow of transactions might require, on a daily basis. FDR never had to extend credit itself since there was full settlement within the same day.

The Revenue concentrated its arguments on the substantial administrative tasks performed by FDR - the bookkeeping, record keeping, transaction authorisation, card issuing etc. FDR focused on the essential nature of its services which was arranging for payments of moneys. To date the courts have held for FDR. They have said that the complex of various services offered by FDR are in reality a single service (with possible minor exceptions). The single service is essentially a service involving payments of money. That brings FDR precisely within relevant VAT exemption in Article 13B of the 6th Directive. That extends the exemption to “transactions, including negotiation, concerning deposit or current accounts, payments, transfers, debts, cheques and other negotiable instruments.”

In the Court of Appeal it was stated “I would have categorised the essential commercial activity here in very simple terms. It consists in the movement of money between card-holder, merchant, issuer and acquirer, for the convenience of the card-holder and the profit of the other three parties. Under the contractual arrangements which the tribunal examined at great length, that activity is essentially (with variations) “outsourced” to FDR. So regarded, the supplies which FDR makes plainly fall within Article 13B(d)(3).”

The matter now passes into the House of Lords, and of course conceivably onwards to the European Court of Justice, which is the ultimate arbiter of VAT disputes. Financial Services companies should watch this space!

Brian Daly is a Partner in KPMG.

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