Theodora-Eirini Dimogianni
HARN60 Master Thesis
Tutor /
Oskar Henkow
02/06/2014
Academic year 2013-2014
Table of contents
Table of contents
Abbreviations
1.Introduction
1.1Background
1.2Purpose
1.3Method and material
1.4Delimitations
1.5Disposition
2.Exemptions for credit services
2.1Introduction
2.2Credit service in the VAT Directive
2.3Granting of credit
2.3.1What is it a granting of credit?
2.3.2The issue of the identity of the lender
2.3.3Incidental credit transactions and the right to deduct
2.3.4Credit granting in Leasing
2.4Negotiation of credit
2.4.1Definition of credit negotiation
2.4.2Applicability of Article 135(1) (b) RVD
2.5Management of credit
2.5.1The meaning of credit management
2.5.2Case law of credit management
2.6Which are the effects of a VAT exempt credit service?
2.6.1A ‘Hidden VAT’
2.6.2Distortion of competition
3.Reforms
3.1Commission’s Proposals on November 2007
3.1.1Background
3.1.2Proposal for a Council Regulation
3.1.3Proposal for a Council Directive
3.2Commission’s Proposal on September 2011
4.Suggestions for taxing financial services
4.1Cash-flow method
4.1.1Introduction
4.1.2How could the cash-flow method work?
4.2Cash-flow method with Tax Calculation Account (TCA)
4.3Truncated cash-flow method with a TCA
4.4How could the cash-flow method operate on the credit services?
4.4.1Granting of credit
4.5Evaluation of the cash-flow method applied to credit services
4.5.1Granting of credit
4.5.2Negotiation and management of credit
5.Conclusion
List of references
Abbreviations
AGAdvocate General of the ECJ
CFEConfédération Fiscale Européenne
DIRECTIVECouncil Directive 2006/112/EC of 28 November 2006 on the common system of value added tax
ECEuropean Commission
ECJEuropean Court of Justice
EUEuropean Union
FECMAFederation of European Credit Management Associations
IBFDInternational Bureau of Fiscal Documentation
MSMember State
PwCPricewaterhouseCoopers
RVDRecast VAT Directive 2006/112/EC of 28 November 2006 on the common system of value added tax
TCATax Calculation Account
UKUnited Kingdom
VATValue Added Tax
1.Introduction
1.1 Background
According to Article 1(2) RVD, ‘VAT is a general tax on consumption applied to commercial activities involving the production and distribution of goods and the provision of services. The common system of VAT applies to goods and services bought and sold for consumption within the EU.’[1] Notwithstanding, there are some VAT exemptions that are applied to specific categories of transactions.For instance,the majority of the financial services including creditare VAT exempt according to Article 135(1) RVD.
Financial services can be defined as‘contractual arrangements regarding intermediation in money, property and credit, as well intermediation in time, risk and persons. They can take various forms, they are simple to produce and can move where the costs of production are lower within the EU or outside of the EU.’[2]Consultancy services, commissions charged by brokers on acquisitions and dispositions of securities supplied by a financial services company via the charging of fees and commissions, are services which are taxed under the normal VAT system.[3]The complexityon the subject of taxationarises with margin-based products such as the bank lending.[4]
According to PwC, one of the difficulties for calculating and imposing the VAT on the financial services is the determination of the fee which must be charged.[5] For instance, a bank’s value added which relates to services provided to both depositors and borrowers, includesalso reimbursementfor possible risk of loss and thus it is not easy to allocate the value added between the two sides of a financial transaction.[6]In addition to the fee issue, CFE observes that due to the fact thatmoney is the consideration for supplies of financial services and simultaneously is the subject of the transaction, an obstacle is generatedfor estimating the remuneration.[7]Moreover, CFE argues that most of the times the transactions include different parties who receive the fee and therefore it is much harder to estimate the relevant consideration.[8]
The necessity of correctly estimating and defining the value added is reflected by the fact thatthe financial services’ VAT exempt status causes several negative consequences. For example, when a financial service is supplied before the last stage in the production procedure, the claiming of input tax credits earlier in the production chain is blocked by the exempt status ofthe financial service.[9]The disadvantage is that the non-creditable tax of the financial organization will be included in the selling price of non-financial goods/services, which will be subject to VAT on the full sale price. The tax in this case cascades[10], that is it applies on both inputs and the final selling price.[11] As a result, for sales of other goods and services which include financial services as inputs there is over-taxation in comparison to other goods and services and this leads to higher prices.[12]
Another complexity which derives from the VAT exempt services’ status is the distortion in competition.CFEclaims that a distortion may arisefrom the fact that the VAT Directives allow a number of several methods for defining the amount of input VAT that should be attributed to taxable and non taxable supplies.[13]Additionally, CFE supports that giving Member States the opportunity to grant an option to tax, results in distortions in competition between Member States that permit the option[14] and those which do not.[15]UnderPwC, the characteristics of the VAT system which maintain distortions of competition are several. For instance, differences between Member States are caused regarding the interpretation of financial services’ notion and a doubt relating to each EU tax authority treatment of particular transactions.[16]
PwC also claims that the distortion of competition can exist with various forms. For example, the financial services firms in EU Member States have an embedded VAT cost which could lead to higher service costs in comparison with undertakings which they don’t have any embedded VAT costs.[17]Furthermore, higher interest rate charges could be generated by the distortion. This distortion relates directly to unfair competition, but probablyhas also consequences for the competitiveness of the general enterprise sector.[18]Moreover, the country location is another form of distortion since a lower standard rate of VAT and/or a particularly favorable VAT treatment of some type of financial service might attract businesses for establishing their offices to the most suitable for them location. If the country which is selected using VAT-related criteria is not optimal in other issues like the language, then this has a goal to impair the competitiveness of the corporation.[19]
1.2 Purpose
The credit constitutes a significant financial service whichplays avital role to thetransactionsbetween the financial and non-financial enterprises with their customers. This thesis will give an effort of making more understandable the VAT treatment of credit in EU via the analysis of how the granting, negotiation and management of credit operate and their current VAT handling. Due to the fact that the tax exemption status of the credit services is a major problem in EU which provokes a lot of serious consequences for the economy and the market, various proposalsfor imposing the VAT on the financial services have been derived from a number of different methodswhich have already been referred in several books and articles. One of them, it has been considered to be the most important of all. This is the cash-flow method which will be generally described and analyzed in order to find a solution for entering the credit services into the normal VAT system. So, the purpose of this thesis is to focus on the importance of the credit services’ VAT treatment in EU,toillustrate the merits and demerits of the cash-flow methodand thus to try to succeed the taxation of the granting, negotiation and management of credit.
1.3 Method and material
Initially, for reaching the goal of successfully writingthis thesis the method which is followed is the traditional legal. Afterwards, books and articles represent the basicsources from where the relevant material and information have been mostly gathered.With regard to the examination of financial services’ VAT treatment and more specifically of credit, RVD is frequently used so as to mention andanalyze itsrespectiveArticles. Moreover, for showing the consequences which are generated from the currentVAT exemptions status and for describing how the suggested methods couldoperate for taxing theexempt financial services, various studiesfrom the most importantmultinational companies to the financial advisory part,as for instance arePwC and Ernst & Young, are used as a precious spring for the integration of this purpose. Finally, a number ofcases from ECJ are utilized for investigating and thusunderstandingin which way the granting, negotiation and management of creditare facedrespecting VATwithin the EUeconomy.
1.4 Delimitations
As it has been previously reported, the subject of discussion in this thesis is the VAT treatment of the credit services withinEU. For the thesis correct analysis, it is comprehensible that there have to bespecificdelimitations. First of all, there won’t be any reference to the way that the credit services are handledoutside of the Community. Then, there won’t be any analysis of how the rest financial services, exceptgranting, negotiation and management of credit,are VAT treated within the EU. In addition, since the type of tax which is discussed is VAT, there won’t be examinedanyother forms of tax which are relevant with the financial services, asfor instance isthe Financial Transactions Tax.Moreover, regarding Article 135(1) RVD, it will be analyzed only the (b) provision as it includes the granting, negotiation and management of credit.The other provisions of the same Article won’t be investigated. For suggesting a way for taxing the credit services, the cash-flow method will bethe onlymethod evaluated. Finally, it has to be noted that the material which is utilized has been collected until the 1st of November 2013. No inclusion of any other material has been done after this date.
1.5 Disposition
This thesis is divided into 5 parts. Originally, the introduction chapter makes a general reference to the notion of financial services, theirVAT treatment, the reasons which have kept these services from not being taxed under the normal credit invoice system and the respective consequences of thisVAT exemption status. Then, the second part of the thesis is wholly focusing to the credit services. It describes the way that the granting, negotiation and management of credit function and also it refers to the relevant Articles of RVD which concern their VAT handling. Furthermore, in the same chapter is investigated the relative case law and are emphasized the effects of their VAT exemptioncondition.Thereafter, the third chapter covers theCommission’s proposals for reforming the VAT legislation regarding the taxation of the financial services. Then, in the fourth part there is a report to the forms of thecash-flow method which is suggested for taxing the financial services andmore specifically there is an assessment of itas a means of taxing the credit. Finally, the last part is the conclusion where the final comments for the problem of the VAT treatment of the credit servicesin EU and its suggested solutionsare included.
2.Exemptions for credit services
2.1 Introduction
The notion of credit derives from the Latin word crederewhich means to trust a person. The basis of this word focus on the real meaning of credit granting, which is the confidence in someone’s capacity and purpose to complete his/her obligations that he/she has agreed to take on when being entrusted with a loan, or instead, goods or services without adirect payment.[20]In the EU economy, concerningthe transactions which take place between the financial and non-financial businesses with their customers, credit is a coreeconomical service.It facilitatesbusinesses or consumers for effectively settling up their economic obligations which have arisen as a result from their purchases. Thecustomers canrequest for a delay on their paymentseven for very small amounts and short terms of period.
The actions of negotiation and management of credit areconsidered toplay an important roleforthe successful integration ofthe credit granting. Occasionally these three servicescan shape a cyclical route.This hypothesis can be justified from the fact that they can start from the part of negotiation with the customer, to move on the management section, then go tothe granting and to finishagainwith the procedure of management. Additionally, if there is a problem with the payment of the loan or there is a non scheduled deferral of invoice’s payment regarding supplies of goods and/or services,there is always a potential to go back from the managementto negotiation.
2.2 Credit service in theVAT Directive
On the subject of the VAT forcredit, Article 135(1) (b) RVD clearly states that ‘Member States shall exempt the granting and the negotiation of credit and the management of credit by the person granting it’. Due to the fact that the VAT exemptions which are appliedcan cause various negative consequences, in several casesit was statedby ECJ that ‘the terms used to specify the exemptions covered by Article 135(1) RVD are to be interpreted strictly, since they constitute exceptions to the general principle that VAT is to be levied on all services supplied for consideration by a taxable person’[21]. Nonetheless,there arespecific credit services which are normally taxed under the credit invoice system.For instance, leasing is one of these services. The definition of lease is given by KPMG, where it declares that‘a lease is the agreement whereby the lessor conveys to the lessee, in return for a payment or series of payments, the right to use an asset for an agreed period of time.’[22]
Concerningthe right to deduct VAT, under Article 168 RVD ‘’…a taxable person shall be entitled to deduct the input VAT in the MS where the transactions take place in so far as the goods and services which obtains are used for taxed transactions.’’[23] Particularly, for the exempt financial services under points (a) to (f) of Article 135(1) RVD, Article 169(c) RVD states that ‘’… a taxable person shall be entitled to deduct the input VAT in so far as the goods and services are used for transactions where the customer is established outside the Community or where those transactions relate directly to goods to be exported.’[24]Therefore, when the undertakings provideVAT exempt financial services including credit within the Community, they arenot capable to recover the input VAT which they pay on the goods and services obtained for the correct function of their businesses and this has as an outcome a ‘hidden VAT’.This non-recoverable tax is a remarkable source of revenue for the governments of theMember States.[25]
2.3 Granting of credit
2.3.1What is it a granting of credit?
Granting of credit can be characterized astheeconomical service where a financial institution or a non-financial enterprise decides to provide to its customer when he/she will ask for it, an economical facilitation. There are two basic ways of granting a credit to a business or consumer. Firstly, when a financial enterprisemakes available the amount of loan which the customer requests and secondly, whena non-financial undertakingacceptsfor a specific period of time a deferral on the purchase invoice’s payment.The deal between the undertaking and the customer includes an interest as reward for the supply of the granting.
The late payment as problem and the willingness for its limitation is shown also in Directive 2000/35/EC,[26]which states that ‘late payment constitutes a breach of contract which has been made financially attractive to debtors in most Member States by low interest rates on late payments and/or slow procedures for redress. A decisive shift, including compensation of creditors for the costs incurred, is necessary to reverse this trend and to ensure that the consequences of late payments are such as to discourage late payment.’
2.3.2The issue of the identity of the lender
In ECJ case law with reference to the creditgranting, the subject of the identity of the lender was a remarkable issue of dispute and for this reasona deeper interpretation of the expression‘by the person granting it’ which is stated in Article 135(1) (b) RVD was needed.
In the Muys case[27],AG Jacobs mentioned that ‘it had become a widespread practice of suppliers to make their own financing arrangements and a limitation of the exemption based on the identity would lead to distortion of trade and of competition.’[28]It seems that the Court in the end rightly declared that there was no limitation based on the supplier’s identity, since the granting of credit is usually provided by both financial and non-financial firms and a possible limitation could cause discriminationandthus a distortion in the competition.Then,with regard to the interest paid as reward for the granting of credit, the Courtissued that where a supplier of goods or services had granted his customerdeferral of payment of the price, in return for payment of interest onlyuntil delivery, that interest did not constitute consideration for the grant ofcredit but part of the remuneration obtained for the supply of goods or services. The Court properly expressed that this amount could not be characterized as interest for the payment’s deferral because generally the customers are not obligated to settle up the requiredinvoice’s amount before the goods or services are delivered /supplied to them. A deferral on payment would have been caused if the service had been provided on a specific time point and after this date, the customer would have delayed the payment.
The identity of the lender was alsoarguedin SDC case[29]but regarding the occasions where points (d) and (f) of Article 135 (1) RVD were implemented.The ECJ issued thatthe expressions'the person granting it'and 'the person who is granting the credit'which were derived from points (b) and (c) of Article 135(1) RVD respectively, verified the fact that the identity of the persons effecting the transactions was irrelevant in determining the transactions exempted under points (d) and (f) of Article 135(1) RVD. Thus, these serviceshad to be VAT exempt regardless of the fact if the lender or even the borrower was a commercial or a financial undertaking. The Court through its decision tries again to keep a balance between the banks and the commercial businesses and to handle both these categories as equal so as to avoid causing them an unfair competition.
2.3.3Incidental credit transactions and the right to deduct
The credit with the form of aloangranted from a holding company to its subsidiarieswas discussed in the EDM case[30].In this occasion, the issue was ifthe credit granting constituted an economic activity and thenif it could be defined as an ‘incidental transaction’ for the computation of the VAT which had to be deducted. AG Léger stated that ‘the granting of loans by a holding company to its subsidiaries couldn’t be an occasional activity. On the contrary, it had to take place with a degree of regularity so that the holding company could obtain income from it on a continuing basis.’[31]In the end,ECJ decided that the annual granting by a holding company of interest-bearing loans to companies in which it had a shareholding and placements by thatholding company in bank deposits or in securities, constituted economic activities carried out by a taxable person and so as financial transactions wereVAT exempted.From my view, the ECJcorrectlyexpressed that the holding company provides a financial service that is to say,grants credit which is VAT exempt since it facilitates economically its subsidiariesnot free of charge but with exchange a specific interest.Afterwards, in this case another important matter was the deduction of VAT. The Courtstated that for calculating the deductible proportion and so if the services had to be excluded from the computation under Article 174(2) (b) RVD[32], were to be regarded as ‘incidentaltransactions’thereof in so far as they involved only very limited use of assets or services subject to VAT.