VAT and debt factoring

The question of the VAT treatment of factoring arrangements has previously considered by the CJEU in MKG-Kraftfahrzeuge-Factoring (Case C-305/01). In that case, the CJEU held that fees charged by a factor under a "true factoring" arrangement involving the purchase of debts amounted to consideration for a service provided by the factor to its client. The referral in A Oy (Case C-232/24) raises the question whether this approach should be adopted in relation to all forms of factoring arrangements, including those which do not involve the purchase of the underlying debts.

The CJEU has now held that all forms of factoring essentially involve VATable supplies of services. The CJEU agreed with the AG that the decision in MKG covers the case of trade or true factoring and also the services provided under quasi or invoice factoring arrangements. In addition, the Court has held that factoring arrangements amount to a single VATable supply of debt collection services.

Background

The case concerns supplies made by a Finnish company which provides financial services, including factoring. The factoring services were of two types:

• "invoice factoring" under which A grants financing to its clients by granting credit based on the client's unpaid invoiced debts up to a total amount calculated by reference to the level of risk of the client's business. Under "invoice factoring", A takes responsibility for collecting the debts, but does not acquire the debts. They are used as collateral for the financing, but the client remains at risk where debtors default.
• "trade factoring" under which A purchases invoiced debts from clients up to agreed amounts. Those amounts are based on A's risk assessment of the client's business. Trade factoring involves the assignment of the debts to A and the transfer of the risk of default to A.

Under the factoring arrangements, A charged clients a range of fees. In particular, the focus of this case is on two types of fee:

• The "factoring commission", a charge levied by A expressed as a percentage of each invoice covered by the agreement. The amount of the fee is calculated in the same way for both invoice and trade factoring, based on an assessment of the length of the invoice payment term and the credit rating of the debt.
• The "arrangement fee", a flat fee charged to clients for activities associated with setting up and activating the factoring process, including money laundering obligations.

A sought a tax ruling from the Finnish tax authorities on the tax treatment of its fees, contending that they were all subject to VAT. This would mean that it was entitled to deduct any associated input VAT. The Finnish tax authorities took the view that the fees were, at least in part, exempt from VAT as consideration for the grant of credit. A appealed arguing that, in the case of invoice factoring, the invoiced amounts were, as a whole, consideration for a service of managing and collecting debts (outside the VAT exemption) and, in the case of trade factoring, where there was no debt relationship with the client, the service was subject to VAT. The Finnish court decided to refer questions to the CJEU concerning the correct application of the VAT rules to the factoring arrangements.

CJEU decision

As regards trade factoring, the Court has held that the position is essentially covered by the decision of the CJEU in MKG. MKG involved "true factoring", which also involved the purchase of debts from a client. The Court noted that the "trade factoring" in this case had essentially the same features (involving the purchase of debts without recourse to the client in the event of default). As decided by the CJEU in MKG, such factoring arrangements involve reciprocal performance with the client paying the factor for relieving the client of the debt recovery and debt risk, which amounts to a taxable supply.

That conclusion was not called into question by the later case of GFKL. That case concerned an isolated sale of debts considered to be doubtful, namely 70 loan agreements that had been terminated and declared mature. In that case the purchase price reflected the actual economic value of the assigned debts, rather than remuneration for a service. In GFKL, "the Court held that an individual sale of mature but defaulted debts, the price of which reflected not the remuneration for a service provided but the actual economic value of those debts, which had fallen below their face value, did not fall within the scope of VAT. By contrast, trade factoring activity such as that at issue in the main proceedings concerns debts which are not due, in respect of which there is nothing a priori to suggest that they will not be repaid in full by the debtors, and is characterised by the provision of a service consisting, for the assignee, in assuming responsibility for collection and the risk associated with those debts in return for the payment of remuneration by the assignor".

The Court also noted that the way in which the consideration was calculated for the trade factoring did not indicate that there was a purchase of the debts for their economic value. The Court highlighted that "the factoring commission represents a percentage of the amount of the debts, the level of which depends not on the assessment, as such, of the economic value of those debts but on the credit rating attributed to them and the length of the remaining payment term. In view of those characteristics, it does not appear that such a commission corresponds to an adjustment of the purchase price of the debts to their real economic value. Rather, that commission must be regarded as consideration for the debt collection service provided by the factor to the client, the value of which increases the longer the payment term and the greater the level of risk assumed by the factor". Equally, the flat-rate arrangement fee were simply consideration for the service supplied by the factor.

As regards invoice factoring, the Court noted that the essential purpose of factoring, irrespective of its manner, is the recovery and collection of debts. There is no reason to justify different treatment, for VAT purposes, between trade factoring and invoice factoring. All such factoring involves, an activity which falls within the concept of debt collection.

What of the argument that invoice factoring, however, involved an exempt grant of credit and part of the consideration for the supply should be attributed to that exempt supply? The Court has rejected that argument, noting that "from the point of view of both the client and the factor, a supply of factoring services constitutes, in principle, a single economic transaction, the main purpose of which is to enable the client to transfer responsibility to a third party for the recovery and collection of its debts, which it would be artificial to split". That analysis applied equally to trade and invoice factoring, where the provision of finance was not made independently of the debt collection service. As such, both the factoring commission and arrangement fees involved in invoice factoring were consideration for a single taxable supply of debt collection subject to VAT.

Finally, the Court held that the provisions of Article 135(1)(d) containing the exception relating to debt collection were sufficiently precise and unconditional so as to have direct effect and can be relied on by taxpayers directly.

Comment

Debt factoring is problematic from a VAT perspective, especially trade factoring arrangements. These essentially involve the purchase of debts by the factor and distinguishing this from cases of straightforward debt purchases (where the supply is from the client to the purchaser rather than the other way) is not straightforward. Nevertheless, the Court has re-emphasised its earlier reasoning in MKG in recognising a supply of services by the factor purchasing debts to the client selling debts on the basis of the broader business rationale for the arrangements.

Equally, the question whether the VAT system should recognise the element of grant of credit involved in invoice factoring arrangements is not straightforward. However, the Court has held that the essential aim of the parties involves debt management and collection, and any element of credit is ancillary.

It should be noted that the approach of the AG in this case is at odds with the approach of HMRC set out in Notice 701/49. In particular, HMRC do recognise some fees charged by factors as being exempt from VAT as in connection with an exempt supply of credit (see in particular para 5.2 below). The decision of the CJEU in this case is not binding in the UK, but may be persuasive, and there may be opportunities for factors to treat the whole of their supplies as taxable to obtain the benefit of input VAT recovery.

5.2 Factoring (including invoice discounting)

Factoring, including invoice discounting, is essentially a form of debt collection and is a taxable supply. However, factors and invoice discounters offer a number of services to their clients and these usually include the prepayment of part of the value of the debt. Consideration attributable to the latter is in respect of an exempt supply of credit.