Supreme Court finds loan administration services are subject to VAT

12 October 2023

The Supreme Court has found that supplies of loan administration services made by Target Group Ltd (Target) did not qualify for VAT-exemption. The decision is potentially relevant to a broad range of outsourced loan services and it will be important for providers of such services to understand the potential implications of the decision.


Target administered loans made by Shawbrook Bank Ltd, a provider of mortgages and loans, to its borrowers. Target's services included operating individual loan accounts, instigating and processing payments due from borrowers, calculating interest and fees, dealing with missed payments and arrears, and handling early repayments and loan closures.

Target argued that its services were exempt from VAT under article 135(1)(d) of the Principal VAT Directive, which exempts "transactions, including negotiation, concerning deposit and current accounts, payments, transfers, debts, cheques and other negotiable instruments, but excluding debt collection" (the payments exemption). Target relied on the fact that it procured payments from borrowers' bank accounts to Shawbrook's bank accounts by giving instructions for payment which were then automatically and inevitably carried out through the BACS system. Target also relied on the fact that it inputted entries into the borrowers' loan accounts with Shawbrook, which it claimed amounted to transactions concerning debts.

Target appealed to the First-tier Tribunal (FTT), which dismissed the appeal, holding that Target's services were transactions concerning payments and transfers, but were excluded from the exemption as debt collection.

Target appealed to the Upper Tribunal (UT), which also dismissed the appeal, but on different grounds. The UT held that Target's services did not fall within the exemption in the first place (so that the carve-out for debt collection was not in issue), because Target did not itself effect the legal and financial changes that characterise a transfer of funds, but merely gave instructions to BACS or financial institutions to do so. The UT also held that Target's services were not transactions concerning current accounts, because the loan accounts did not have the features or functionality of current accounts.

Target appealed to the Court of Appeal on three grounds: 

  • that the UT erred in law by unduly narrowing the scope of the exemption for transactions concerning payments and transfers;
  • that the UT erred in failing to consider the full scope of the exemption for transactions concerning debts; and
  • that the UT erred in law by applying an unduly narrow definition of the term current account.

The Court of Appeal dismissed Target's appeal on all three grounds. Target subsequently appealed to the Supreme Court.

The Supreme Court Decision

The Supreme Court rejected Target's arguments and found that Target’s supplies were subject to VAT. The Supreme Court applied the CJEU case law, which established that the exemption only applies to transactions that have the effect of transferring funds and entail changes in the legal and financial situation of the parties. The Supreme Court held that Target's services did not meet this criterion as they did not involve the execution of an order for payment or transfer, but merely the giving of instructions to other financial institutions to do so.

The Supreme Court acknowledged that following the 1997 decision of the CJEU in Sparekassernes Datacenter (SDC) v Skatteministeriet (Case C-2/95), what remained arguably unclear was whether the services must in themselves have the effect of transferring funds and making changes in the legal and financial situation (the narrow interpretation) or whether it was sufficient for them to have that causal effect in the sense that they automatically and inevitably resulted in such a transfer and entailed such changes (the wider interpretation). The wider interpretation had been adopted by the Court of Appeal in Customs and Excise Commissioners v FDR Ltd [2000] STC 672 (FDR) in the year 2000 and was relied on by Target.

The Supreme Court overruled the Court of Appeal’s decision in FDR, finding that it was based on an incorrect interpretation of the CJEU case law, and that the exemption required a functional participation and performance of the transfer, not merely a causal link.

The Supreme Court also found that the making of entries by Target in the borrowers’ loan accounts did not result in any changes to the legal and financial situation between Shawbrook and the borrowers. The entries only reflected expected payments that were initially assumed to have been made and were recorded as such. Where a payment was not in fact made the entry would be reversed. The loan account was therefore no more than a ledger, recording the effect of payments made by customers to Shawbrook but not effecting such payments.

Concluding thoughts

The Supreme Court's judgment confirms that the VAT exemption for payments and transfers is to be interpreted strictly, and that it only applies to services that perform the specific and essential functions of a payment or transfer, not to services that are preparatory, ancillary or administrative in nature.

Since the 2003 decision of the Court of Appeal decision in Commissioners of Customs and Excise v Electronic Data Systems Ltd [2003] EWCA Civ 492 (EDS), which followed FDR in adopting the wider interpretation of the payments exemption, HMRC have drawn a distinction between outsourced loan services where the service provider is involved in the grant of the loan and those where it is only involved in administering existing loans. In HMRC’s view the latter (closed book arrangements) are taxable whereas the former may be VAT-exempt.

The decision in Target supports HMRC’s approach to closed book arrangements. HMRC have traditionally relied on the carve-out of debt collection from the payments exemption to support their approach. Following the decision in Target, such reliance is probably unnecessary because such services are unlikely to qualify as payment services in the first place.

The decision may also cause HMRC to question their acceptance of VAT-exemption for services that cover the whole lifecycle of a loan (including the initial grant). Their policy follows the Court of Appeal decision in EDS, which followed FDR in adopting the wider interpretation of the payments exemption, albeit in the context of services that covered the entire lifecycle of the loans. The decision in Target arguably calls into question the decision in EDS and HMRC may therefore be tempted to re-examine their policy.

However, it is noteworthy in this regard that the Supreme Court in Target chose to endorse the four main reasons given by the Court of Appeal for rejecting Target’s appeal, one of which was that Target did not provide loan origination services. It would seem to follow that the Court of Appeal and the Supreme Court view the inclusion of loan origination in a package of outsourced loan services as supporting the case for VAT-exemption and perhaps their mentioning of origination can be seen as a tacit approval of the decision in EDS.  

It is also worth noting that the VAT-exemption for intermediation in the granting of a loan will come into play where the service provider originates loans on behalf of a lender. In EDS the First Tier Tribunal concluded that had the services in question not fallen within the payments exemption then they would have been exempt as services of loan intermediation. While the Court of Appeal declined to reach a concluded view on the point, it nonetheless acknowledged the force of the tribunal’s conclusion and stated that the fact that EDS undertook the vast majority of functions prior to and after the granting of the loan pointed towards the services being VAT-exempt as intermediation.

We will have to wait to see if any updates are made to HMRC’s policy and whether further case law (presumably involving a service provider with a three-letter abbreviated name, to follow a tradition) emerges to further clarify the scope of the relevant exemptions.