Finanzamt Essen-NordOst v GFKL Financial Services AG (Case C-93/10)
The ECJ provides some comfort to assignors and assignees of financial assets at a discount to face value. Provided that the discount is not calculated by reference to a fee notionally payable to the assignee for taking on the economic risk of default on the assets, then the value of the discount should not be treated as consideration for a VAT-able supply of services by the assignee to the assignor. This clarifies earlier European case law and should remove at least one risk factor from securitizations and other assignments of portfolio receivables.
27 October 2011 saw the release by the ECJ of its decision in Case C-93/10 ("GFKL"). The court had been asked for a preliminary ruling on whether the purchaser of defaulted loans at a discount to face value supplies a taxable service to the assignor (or "originator") of those debts. Two subsidiary questions were also referred to the court in the event that the answer to the first question was in the affirmative. The referring court was the German Bundesfinanzhof.
The ECJ found on the facts that there was no taxable supply by the purchaser to the originator and accordingly did not provide a response to the subsidiary questions.
The decision will be seen as positive by most taxpayers, particularly those involved in securitizations, and it in any case is welcome in clarifying the VAT position of discount asset assignments following the 2003 decision in Finanzamt Gross-Gerau v MKG-Kraftfahrzeuge-Factory GmbH (Case C-305/01) ("MKG"). In the MKG case, the ECJ had - broadly – decided that in both recourse (where the risk of borrower default remains with the originator) and non-recourse (where the purchaser assumes the risk of borrower default) factoring, the acquisition of a defaulted loan portfolio at a discount to face value represented a supply of services by the purchaser to the originator. Importantly in that case, the discount in question was calculated by reference to a 2% factoring commission and 1% del credere fee. Some Member States had interpreted the MKG decision as applying to all assignments of receivables at a discount (regardless of the basis for that discount). In GFKL, the discount was intended to reflect the actual economic value of the assigned loans at the time of assignment.
In securitizations, receivables are sometimes assigned by an originator to an SPV (whether that be a note issuer or a receivables trustee) at a discount to face value to reflect the risk of borrower default (and other factors, including the time value of money). The MKG decision had potentially complicated such transactions. Where such an assignment was at a discount, treating that discount as consideration for a taxable supply would significantly add to the cost of the securitization (most originators being financial institutions with limited input tax recovery) and would complicate the SPV's compliance position.
In the UK, this risk was partially addressed by the High Court decision in MBNA Europe Bank Ltd v HMRC  EWHC 2326. There, the UK court found that the SPV provided a "securitization service" to the originator and, although the court had the opportunity to consider the MKG decision, it omitted to classify that service as taxable for VAT purposes. Typically, advisers have concluded in securitization transaction opinions that to the extent that a securitization service is within the scope of VAT, it is an exempt supply within Article 135(1)(d) of the principal VAT Directive (2006/112/EC). This conclusion allowed the potentially problematic MKG decision to be sidestepped in most cases.
The GFKL decision, however, now clarifies that where receivables or other assets are assigned by Party A to Party B at a discount to face value and where that discount is not calculated by reference to consideration (or notional consideration) for a supply of services by Party B to Party A, then Party B is not carrying out an economic activity in acquiring those receivables from Party A (albeit that it takes on the risk of borrower default). Accordingly, there is no supply by Party B to Party A.
The GFKL decision is not a complete solve, however. In distinguishing the MKG case on its facts, the ECJ has not provided a one-size-fits all answer to the issue of assignments at a discount. In MKG, the relevant discount was very clearly calculated by reference to a notional fee for services supplied by the purchaser to the originator. In GFKL, the relevant discounts were very clearly calculated by reference to an agreed economic value for the portfolio of defaulted loans (taking into account the risk of total default and also the interest element of the outstanding loans over the anticipated collection period) at the time of assignment. Whilst it is clearly advisable for taxpayers to document their negotiation of the relevant discount in line with the facts in GFKL, rather than those in MKG, would this be sustainable in an arm's length arrangement? Surely the purchaser of defaulted loans anticipates a rate of recovery higher than the price it pays for those loans and – it could be argued – the difference between anticipated recovery and acquisition price represents an agreed consideration for a service supplied by the purchaser to the originator (that of assuming the risk of default). Shades of gray between the two decided cases will surely lead to further difficult decisions for the Member State courts. Fortunately, in most securitizations, excess returns to the SPV over the purchase price for the receivables are funneled back to the originator as deferred consideration or are otherwise recycled within the overall transaction terms, rather than accruing to the benefit of the SPV as consideration (for a securitization service or otherwise) and on this basis the decision in GFKL provides comfort that the assignment of receivables at a discount in these circumstances should not trigger an unexpected (and significant) VAT liability.