Media Briefing Note: ECJ Confirms Assignment of Debts at Discount is not Taxable Supply of Debt Collection by Assignee
28 October 2011
LONDON, 28 October 2011 - Commenting on the Court of Justice of the European Union (ECJ) ruling in Finanzamt Essen-NordOst v GFKL Financial Services AG (Case C-93/10) yesterday, Thursday 27 October, Greg Sinfield, partner in Hogan Lovells tax practice, said:
"The European securitisation industry will sleep more easily after the decision of the ECJ in GFKL. The case provides a practical solution that removes the threat of an unwelcome VAT charge."
Since the decision of the Court of Justice of the European Union (ECJ) in MKG-Kraftfahrzeuge-Factoring (Case C‑305/01) in 2003, there has been continuing uncertainty about the VAT treatment of assignments of debts at a discount. Some EU Member States interpreted the MKG case to mean that the discount was consideration for a debt collection or factoring service by the assignee which was subject to VAT. This uncertainty was of great concern to the securitisation industry where the imposition of irrecoverable VAT would have made many securitisations uneconomic.
In Finanzamt Essen-NordOst v GFKL Financial Services AG (Case C-93/10), the ECJ has now clarified the scope of its earlier ruling in MKG. The ECJ has ruled that a person who purchases debts at a discount on a non-recourse basis does not make a supply of services and does not carry out an economic activity for VAT purposes when the difference between the face value of the debts and the price paid by the assignee reflects the actual economic value of the debts at the time of their assignment. This decision will come as a relief to all businesses who acquire receivables and it will be particularly welcome to those engaged in securitisation transactions.
GFKL bought debts arising from mortgages from a German bank on a non-recourse basis. In light of the considerable number of defaults and the value of the effective grant of credit by GFKL to the bank, the parties agreed that the value of the debts was only slightly more than half their face value and then fixed a purchase price of €365,000 less than that. GFKL accounted for VAT on the €365,000 but submitted that no VAT was due at all. The German tax authority took the view that MKG must account for VAT on the discount. GFKL appealed and the German tax appeal court referred the case to the ECJ. The principal issue in the case was whether, by buying the debts at a discount, GFKL made a supply of debt collection or factoring services to the seller which was liable to VAT.
In MKG, there was a factoring commission and a del credere fee which were straight percentages of the face value of debts purchased agreed between MKG and its client in advance of the debts being assigned. The ECJ held that the factoring commission and del credere fee constituted actual consideration for a supply of taxable debt collection services by MKG.
In GFKL, the ECJ distinguished MKG on its facts. The ECJ emphasised that, in MKG, the assignee of the debts undertook to provide factoring services to the assignor, in return for which it received payment, namely factoring commission and a del credere fee. In contrast, GFKL did not receive any consideration and, therefore, did not carry out an economic activity or make any supply of services. The difference between the face value of the assigned debts and the purchase price of those debts was not consideration for any supply of services but a reflection of the actual economic value of the debts at the time of assignment. The ECJ held that the discount was not "a payment intended to provide direct remuneration for a service supplied by [GFKL]".
What GFKL means in practice
Analysing both MKG and GFKL, it is clear that, in the absence of consideration agreed between the parties for the provision of the debt collection service; there is no supply for VAT purposes. Where debts are assigned at a value less than face value which is calculated on the basis of net present value by reference to rates of default and interest rates, there is no separate consideration for the provision of any service by the assignee.
It is unclear, however, how the GFKL decision will apply in practice. The principle seems to be that the discount is not consideration for a separate supply because the amount paid represents the actual economic value of the debts. How is that true value determined if not by agreement between the parties? Would MKG have been decided differently if the parties had not specified a factoring commission or del credere fee but simply agreed the "actual economic value" at an appropriate level (incorporating, in economic terms, the commission and fee)?
The decision in GFKL establishes that the German tax authority's interpretation of the MKG case, which caused so much uncertainty for those involved in debt assignments, was wrong. As is often the case with the judgments of the ECJ, the judgment in GFKL still leaves space for interpretation in practice (and in future cases). However, the GFKL decision clearly removes much of the uncertainty about the VAT treatment of discounts in the context of the assignment of receivables. The GFKL case shows that, if properly documented, the mere assumption of the credit risk when acquiring a loan at a discount is not treated as a supply of a service for consideration.
It will be interesting to see how tax authorities in Germany and the other Member States respond to the GFKL judgment.