Target sent instructions that automatically moved money through the banking system. Did that mean Target itself provided a VAT-exempt transfer service? The answer turned on what changed the legal position of borrower and lender. The Supreme Court examined both the payment instructions and the entries Target made in the loan records.
What Target did and why VAT was in dispute
Shawbrook Bank lent the money. Target administered the loans, calculated what borrowers owed and recorded repayments in their accounts. For direct debits it prepared an electronic file for BACS, the automated bank clearing system. BACS processed the instructions and the banks transferred funds. Target’s records initially showed an expected payment as received and reversed it if collection failed.
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VAT is charged on services supplied for consideration, but article 135(1)(d) of the Principal VAT Directive exempts specified financial transactions: transactions, including negotiation, concerning deposit and current accounts, payments, transfers, debts, cheques and other negotiable instruments, excluding debt collection. A separate exemption covers the management of credit only when it is carried out by the person who granted the credit. The domestic provisions reflect the Directive, but nothing turned on their precise wording. Target said that its services fell within article 135(1)(d) on two grounds: its instructions automatically and inevitably produced payments through BACS, and its entries in the loan accounts were transactions concerning payments, transfers or debts.
Before the First-tier Tribunal, HMRC’s main argument was that the supply was debt collection and therefore outside the exemption. The Tribunal found that the supply did include transactions concerning payments or transfers, but that its predominant nature was debt collection, so it was taxable. After the Court of Justice decided DPAS, HMRC challenged the first part of that conclusion. The Upper Tribunal held that giving a financial institution an instruction to make a payment is not an exempt supply, even if the instruction is a necessary step, and that Target’s accounting entries did not change anyone’s legal and financial position. It treated the services as standard-rated and did not decide the debt-collection question. The Court of Appeal agreed and likewise left that question undecided.
What counts as executing a transfer?
The Court considered the exemption as it applied under the VAT Directive. It had to be read strictly in its context. The question was whether the supplier performed the characteristic functions of a transfer. A service could be commercially essential yet fall outside that definition.
In SDC, the Court of Justice described a transfer as the execution of an order to move a sum of money from one bank account to another. It is characterised by a change in the legal and financial situation between the person giving the order and the recipient, those parties and their banks, and sometimes the banks themselves. Viewed as a whole, exempt services must have the effect of transferring funds and must entail that change. It is not enough that a service is an essential part of completing an exempt transaction, or that it is a merely technical supply.
In FDR, the Court of Appeal had adopted a wider reading. FDR prepared instructions which BACS carried out automatically and without exercising judgment. The Court held that this was enough, because the inevitable result was the required change in legal and financial position and BACS was only the agency through which FDR effected the transfer. Later domestic cases followed that approach. Lord Hamblen held that later Court of Justice decisions, especially Bookit II, National Exhibition Centre and DPAS, resolve the uncertainty in favour of the narrower reading. In DPAS, the supplier asked financial institutions to transfer money under direct-debit arrangements. That did not itself make the legal and financial changes which characterise a transfer. It was a preparatory step, even though it was essential to the payments. An earlier dental-plan decision, Axa, had not examined the scope of the exemption; it had decided the debt-collection exception.
Later decisions made clear that causing a transfer is different from executing it. The Court overruled the contrary conclusion in FDR. A non-bank supplier could qualify for the exemption if its own service made the relevant legal and financial change. Sending instructions which another party was bound to execute did not meet that test.
Why neither part of Target’s work qualified
Target’s payment instructions therefore failed. Its role was functionally indistinguishable from the payment administration in DPAS. It passed BACS the information needed for the borrowers’ and Shawbrook’s banks to move the funds. It started the chain, but it did not debit or credit those bank accounts, execute the transfer, or assume responsibility for achieving it. If a direct debit failed or was cancelled, responsibility would lie with the third party effecting the transfer, not with Target.
The loan-account entries failed on the facts found by the First-tier Tribunal. Expected payments are initially assumed to have been made, and credits are entered on that basis. If the payment was not made, the entries are reversed. An entry of an expected or assumed payment cannot itself transfer funds or change the parties’ legal position. The accounts are ledgers recording the effect of payments made by others, not the means by which those payments are effected.
ATP PensionService showed that accounting entries by someone other than a bank can fall within the exemption, but only where they change the legal and financial situation. There, crediting pension accounts could transform an employee’s claim against an employer into a claim against the pension fund, if the national court so found. Target’s reversible entries for expected payments did not legally change anything. Momm v Barclays Bank International Ltd, where entries between two customers of the same bank completed a transfer, was not analogous to these parties or these entries.
Verdict: The Court unanimously dismissed Target’s appeal. Neither the BACS instructions nor the entries recording expected payments qualified for the exemption. The Court did not need to decide whether the service also amounted to debt collection.
Source: Target Group Ltd v Commissioners for His Majesty’s Revenue and Customs [2023] UKSC 35
