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Tuesday, 4th August 2020
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Debt factoring and VAT - case Back  
The High Court has ruled on the the treatment of debt factoring in the context of VAT. It has rejected a Revenue argument that non-recourse factoring where the vendor of the debts collected the debts on an outsourced basis on behalf of the factor was a supply of exempt services for VAT purposes and confirmed that it was a taxable supply.
Hagermayer case
Hagermayer engaged in non recourse factoring of debts but outsourced the debt collection function back to the vendor of the debts. Under the contract for the factoring of the debts it was free to collect them itself, or subcontract to any third party, which could include the vendor of the debts. This outsourcing of debt collection back to the vendor of the debts was the reason the Revenue challenged Hagermayer's claim that the factoring was a taxable service.

The European Court of Justice (ECJ) had considered the VAT treatment of factoring in the MKG case in 2003. In that case the ECJ had rejected a German view that pure factoring ie the purchase of debts on a non recourse basis with the purchaser responsible for collection, was not a VAT service at all but the acquisition of a passive investment by the factoring company. The ECJ had also held that factoring was not an exempt service for VAT purposes and defined the essential elements of factoring in that context as being the assumption of the risk of debtor default, and the assumption of the task of collection of the debt.

VAT is chargeable on the supply of services for consideration in the course of a business. Some services concerned with dealing in payments are treated as exempt services. The EU sixth directive (which harmonises VAT to a large extent across the EU) excludes from the exempt 'dealing in payments' heading the services of debt collection and of factoring. Thus where debt collection and factoring are carried on as a business, the services rendered are liable to VAT, and an entitlement arises to input recovery on costs.

However the directive has no definition of what it means by "factoring", and in most of the foreign language versions of the directive, there is no reference to factoring in this context with only debt collection being excluded from the list of credit related services which are treated as exempt. The ECJ had in the MKG case supplied the necessary definition of factoring in this context and also held that references to "debt collection" in those language versions that did not also include a reference to factoring as being taxable, was intended to encompass factoring.

The High Court judgement
The High Court arrived at the conclusion that outsourcing of debt collection, provided the factoring company had the primary responsibility for it, did not deprive the activities of the factoring company of the status of vatable factoring services.

The High Court held that there were two separate contracts between Hagermayer and the vendor company. One contract related to the sale of the debt on a nonrecourse basis with Hagermayer responsible for collection; and the other outsourced the collection back to the vendor company. The fact that Hagermayer was free to collect the debts itself, or choose a debt collection agency to do so rather than outsourcing it to the vendor, seems to have been importance to the conclusion reached that the transaction was taxable.

Arguably, if the vendor had in the contract for the sale of the debts retained the right and the obligation to collect the debt (as in some cases it might wish to do, so as to preserve customer relations), and had the only service provided by Hagermayer to the vendor been that of taking on the risk of default, it might have been held that the service was not one of factoring as defined by the ECJ for VAT purposes. The ECJ in the MKG case had held that quasi factoring (ie where the factoring company undertake collection but purchase the debt on a recourse against vendor basis) also constituted factoring in the VAT sense. This emphasised the centrality of the collection service in considering when the purchase of a debt constitutes factoring for VAT purposes.
Of its nature, all factoring involves a transfer of funds between the purchaser of the debt and the vendor and therefore could be seen as including a provision of finance by the purchaser to the vendor. The provision of finance is normally an exempt service for VAT purposes. But where the transaction under which it might be argued that finance is provided is properly to be characterised for VAT purposes as factoring, it would seem that the even the element of it that constitutes provision of credit becomes taxable. This point was not explicitly dealt with in either the MKG case or the Hagermayer case and to that extent may be open to challenge, but it does seem implicit in the MKG case decision.

The Hagermayer decision is of importance to any company which buys or sells debts in the course of a business. It is a complex area and companies who might be affected should review their operating procedures and standard agreements, and ensure that those who enter into business in this area are familiar with the VAT implications of various forms of factoring. Restructuring of arrangements will be required in certain transactions in order to avoid an irrecoverable VAT cost arising.

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