If it wasn’t for the word ‘‘when”
In its MKG decision dated 26 June 2003 (C-305/01) the European Court of Justice (“ECJ”) ruled that each kind of factoring – i.e. non-recourse and recourse factoring – qualifies as a service subject to value added tax (“VAT”). The Federal Ministry of Finance (“FMF”) interpreted this MKG-decision in a way that each purchase of receivables qualifies as VAT-able factoring provided that the purchaser assumes the collection of the purchased receivables. This simple view by the FMF has been disputed from the outset within German judicature and literature; this is in particular true with regard to the purchase of non-performing loans (”NPL”).
The fiscal court of Düsseldorf on 15 February 2008 decided (1 K 3682/05 U) that the acquisition of a NPL portfolio with the assumption of the collection of the receivables could not be, different to the opinion of the FMF, classified as factoring subject to VAT but as a VAT-exempt turnover with receivables (rendered from the seller to the purchaser). The defendant tax office appealed against this decision and with its resolution dated 10 December 2009 (V R 18/08) the Federal Fiscal Court, inter alia, referred the following question to the ECJ:
Does the sale of defaulted debts constitute, on account of the assumption of responsibility for debt recovery and the risk of loss, a service for consideration and an economic activity on the part of the purchaser of the debts even if the purchase price is not based on the face value of the debts, with a flat-rate reduction agreed for the assumption of responsibility for debt recovery and the risk of loss, but is set by reference to the risk of loss estimated for the debt concerned, with only secondary importance attached to the recovery of the debt compared to the reduction for the risk of loss?
Judgment by the ECJ
Contrary to the fiscal court of Düsseldorf the ECJ took the position that the sale of a NPL portfolio does not fall within the scope of the VAT Act, i.e. pursuant to the opinion of the court such a transaction is not taxable at all and no exemption from VAT is therefore needed.
In its reasons given for the judgment, the ECJ firstly pointed out that the subject of the MKG-decision was the VAT treatment of factoring services (against payment) and that the case at issue could not be compared with this former case.
Pursuant to the opinion of the ECJ the nonapplicability of the VAT Act results from that the purchaser of the receivables does not receive a consideration for his services rendered. In this regard the ECJ clarified that the discount agreed between the parties on the face value of the receivables does not constitute such a consideration but reflects the actual economic value of the transferred receivables at the time of the assignment.
Thus, the ECJ denies that the purchase of NPLportfolios is subject to VAT and does therefore not answer the remaining question raised by the Federal Fiscal Court.
It needs to be noted, however, that the ECJ defined the conditions for a “free of charge” transaction in more detail at the end of its statement as well as in the operative provisions of the judgement. Pursuant to the ECJ in the course of a sale of NPLs, the purchaser of the receivables does not receive a consideration for his services “when the difference between the face value of those debt and their purchase price reflects the actual economic value of the debts at the time of their assignment”.
We welcome the decision by the ECJ since the long lasting uncertainties whether or not the sale of NPLs is subject to VAT are solved and a VAT burden could be avoided if the parties to the agreement make sure that the purchaser does not receive a consideration for his services.
The definition by the ECJ with regard to the absence of a consideration, however, may provide grounds for interpretation since it is not clear what position the ECJ would have taken if the purchase price did not equal the actual economic value of the receivables at the time of their assignment. Generally, it could always be argued that a purchase price agreed between unrelated parties always equals the economic value of the sold receivables. It needs to be seen, however, whether and how the German tax authorities will take advantage of the loophole opened by the ECJ. It may be possible, for example, that the parties are obliged to proof that the discount on the face value of the receivables actually led to their economic value.
Notwithstanding this, the decision made by the ECJ is quite positive since the risk that future NPL transactions are subject to VAT could be mitigated or excluded by ensuring that the contractual arrangements do not provide for a remuneration for the services which may be rendered by the purchaser of the NPL to the seller.