Acquisition of non-performing loans

On 2 December 2015 the Federal Ministry of Finance released a guidance letter that adopts the tax authorities’ published VAT regulation on the acquisition of non-performing loans to the recent case law of the ECJ and the Federal Supreme Tax Court (Bundesfinanzhof, “BFH”) (cf., ECJ as of 27 October 2011, C-93/10 (GFKL); BFH as of 26 January 2012, V R 18/08; as of 4 July 2013, V R 8/10).

The guidance makes clear and removes any uncertainty that the transfer and acquisition of non-performing loans is a VAT-exempt transaction with receivables.

In the past, in the context of the acquisition of receivables (i.e., not only non-performing receivables) the tax authorities treated the collection activity of the purchaser and, as the case may be, the assumption of the credit risk as a VAT-able service by the purchaser to the seller. The difference between the nominal value of the receivables and the purchase price (i.e., the discount) was thus subject to VAT.

In light of the significant discounts on nominal value that are typically applied in non-performing loan transactions the tax authorities provided some relief to the taxpayers by way of administrative guidance permitting seller and the purchaser to agree on an economic value or real value below the nominal value to avoid a totally absurd result (i.e., 19% VAT on the full amount of the economically worthless discount element).

As a result relatively complex and to a certain degree artificially looking VAT clauses were required and implemented in practice. The necessity for that has gone and insofar the revised VAT regulation provides for a simplification. In the transactional practice taxpayers had from time to time already made use of the above mentioned new case law over the past two to three years.

The flipside of the revised VAT regulation is that the purchaser of non-performing loans is not able to deduct any input VAT that he incurs in respect of the acquisition costs (e.g., legal advice, valuation of portfolio) and on-going costs of managing the portfolio. This may be economically more disadvantageous than paying VAT on the discount element of the purchase price.

The Federal Ministry of Finance thus provides for a grandfathering rule that enables purchasers to continue to apply the previous VAT guidance provided that the transfer of the non-performing loans occurs before 1 July 2016, or, in context of revolving transactions under a framework agreement, the agreement is entered into before that date and the transfer occurs prior to 1 January 2019.

The acquisition of non-performing loans is to be distinguished from the mere collection service where the credit risk remains with the seller. In these situations the revised previous VAT guidance continues to apply.

Acquisition of performing loans

Despite the above mentioned case law whose principal statements could be applied to the acquisition of performing loans alike and would result in the conclusion that the transfer of performing loans is also VAT-exempt, the tax authorities uphold their existing VAT guidance in this respect.

In the view of the tax authorities the purchaser of a performing loan performs a VAT-able service to the seller. Since the agreed discounts on nominal value are much smaller in this category as opposed to the non-performing category the potential VAT liability is consequently lower.

However, certain professionals who predominantly provide VAT exempt services and typically sell their receivables against customers to factoring entities (e.g., doctors), are not able to claim an input VAT deduction with respect to this VAT liability. In this case, the  VAT liability continues to constitute an incremental cost of business. Attempts to reduce the VAT liability by way of transforming the prefunding element (i.e., time lag between purchase price payment to seller and collection of receivable by factoring entity) into a VAT-exempt lending component have been attacked by the tax authorities (BFH as of 15 May 2012, XI R 28/10).

Securitisations and other asset-backed-financing transactions

For this type of financing transactions there continues to be available specific guidance in the VAT regulation which is not repealed or otherwise modified by the newly published guidance letter.

If the purchaser of a receivable does not assume the collection service with respect to this receivable and the seller continues to collect in its own name but on the behalf of the purchaser the above-described VAT regulation on the acquisition of performing loans does not apply.

The sale and transfer of the receivable is VAT-exempt.

In this category fall typically securitisation transactions and other structured finance transactions that are backed by receivables (e.g., covered bonds).

Since the sellers of the receivable portfolios in this category are typically banks and financial institutions which have little or no potential to recover input VAT, the funding costs of theses securitisation or asset-backed-transactions would – absent the specific guidance – be increased in the amount of the non-recoverable VAT on the discount and the servicing fee.