Outsourcing VAT exempt intermediary services

The FTT has held that outsourced services provided to a UK company providing financial intermediation services between merchants and merchant acquirers qualified as exempt financial intermediation services themselves: eMerchantPay Limited v HMRC [2022] UKFTT 334. The FTT rejected HMRC’s arguments that the services provided were merely sub-contracted clerical services and subject to VAT at the standard rate.

The decision is an important reminder of how outsourced financial services may themselves fall within the exemptions, even when relying on the position of the main contracting party as an intermediary. It is not essential that the person to whom the services are outsourced should themselves have any contractual arrangements with the parties they are bringing together, just that the nature of the services they perform has the effect of bringing those persons together for receipt of exempt financial services.

The decision of the Court of Appeal in Target Group Ltd v HMRC [2021] EWCA 1043 may have created some uncertainty around the scope of outsourced exempt services and it is to be hoped that the Supreme Court, which has recently granted permission to appeal, will help to clarify both the scope of the exemptions and the extent to which outsourced services may qualify for those exemption.

Background

The eMerchantPay group included a UK company (EMPL) and a Bulgarian company (EMPO). EMPL was the main contracting entity of the group and operated as a payment services provider (PSP) whose role was to introduce merchants to card acquirers. It would attract merchants who needed payment services of credit card institutions, conduct due diligence on the merchant in question and then introduce it to one of the card acquirers. EMPL entered into agreements with the payment provider or card acquirer to introduce business to them in return for an agreed commission or profit share. EMPL also entered into agreements with merchants so as to enable these merchants to use its services and be introduced to a card acquirer. These agreements required EMPL to carry out due diligence on merchants, provide payment processing and customer support services to merchants, provide technology in the form of a platform for payment, market card acquiring services to merchants and guarantee debts to merchants.

However, EMPL had no employees (other than three directors) and outsourced essentially all of its activities to EMPO. EMPO employed approximately 50 employees in Bulgaria. The underwriting and account management activities constituted the main part of the services provided by EMPO to EMPL, including following up leads on potential merchant clients, carrying out due diligence on them and processing applications. Actual payment processing was done through the use of technology and required minimal human involvement.

EMPL considered that the services it received from EMPO fell within the exemption as intermediary services under VATA 1994 Sch 9 Group 5 item 5 (Article 135(1)(d) of the Principal VAT Directive). HMRC, however, considered that the supplies were taxable and not exempt supplies and raised assessments on EMPL on the basis that it should have reverse charged the relevant VAT.

FTT decision

HMRC relied on the decision of the ECJ in CSC Financial Services (Case C-235/00) where the Court stated that: “On the other hand, it is not negotiation where one of the parties entrusts to a sub-contractor some of the clerical formalities related to the contract, such as providing information to the other party and receiving and processing applications for subscription to the securities which form the subject-matter of the contract. In such a case, the subcontractor occupies the same position as the party selling the financial product and is not therefore an intermediary who does not occupy the position of one of the parties to the contract, within the meaning of the provision in question.”

The FTT rejected the contention that EMPO was doing no more than carrying out “clerical formalities”. It was clear that EMPO did far more than that and, standing back and looking at the services as a whole, it was clear that the core of the service provided by EMPO to EMPL related to those elements which were essential in bringing merchant acquirers together with merchants. In particular, EMPO’s activities were focussed on due diligence and “onboarding” of merchants – it was clear that this is what EMPO committed most of its human resources to doing.

The FTT also rejected HMRC’s argument that the principal feature of the combined single composite supply made by EMPO was payment processing. It was the introduction of merchants to merchant acquirers which was the main feature of the supplies. Moreover, it made no difference that the contractual arrangements entered into by EMPL provided for payment based on the number of transactions processed by EMPL.

Finally, the FTT rejected the suggestion that there was any contradiction in holding, on the one hand, that the services provided by EMPO to EMPL are part of the bundle of services provided to EMPL so as to enable the latter to fulfil its contractual obligations, and on the other, holding that these supplies are properly characterised as intermediation. “Developing this a little further: the reason why the activities are being carried out (ie to enable EMPL to fulfil its contractual obligations) is irrelevant if there is, in fact, financial intermediation being carried on.”

Comment

The VAT treatment of outsourced services, particularly in a financial services context, can cause significant problems. The question, ultimately, is whether the outsourced services themselves can fall within the scope of the financial exemptions or whether they merely amount to technical or clerical services to the actual provider of exempt financial services. This can be a difficult question and there may be no bright line between the two.

HMRC’s guidance recognises this situation, commenting that: “Outsourcing is a contentious area. Financial institutions may seek exemption on the services they buy in, because of their inability to recover input tax that then forms an overhead of their business. This has led to a lot of litigation and uncertainty”.

In general, it is clear that the finance exemptions are not dependent on the identity of the supplier – it is the nature of the activities carried out that is determinative. As such, outsourced services may qualify as exempt services, especially where viewed broadly, as in this case, they form a distinct whole, fulfilling in effect the specific, essential functions of a service described in the exemptions (based on the ECJ decision in Sparekassernes Datacenter (Case C-2/95) [1997] STC 932. Indeed, HMRC’s guidance recognises this position, stating that “There is no reason in principle why a sub-contracted service should not fall within the scope of the financial exemption.”