VAT can be a somewhat curious tax. It is, according to the Court of Appeal: “a kind of fiscal theme park in which factual and legal realities are suspended or inverted” (Royal & Sun Alliance Insurance Group plc v C & E Comrs [2001] STC 1476, para 54). After more than 30 years, it is still a tax obsessed with why heated pastries are hot, with two Tribunal decisions within two months this year reaching opposite conclusions (Ainsleys of Leeds Ltd (2006) Decision 19694and Jannicke Wallace t/a The Cornish Pasty (2006) Decision 19793).
The recent High Court decision of MBNA Europe Bank Limited v HM Revenue & Customs [2006] EWHC 2326 (MBNA) has thrown up another curious phenomena – the case of the disappearing supply1.
The core of the MBNA decision is that where a bank assigns debts to a special purpose vehicle set up to carry out a securitisation, the assignments of the debts do not constitute supplies. They are “in theory capable of constituting supplies” but “belong to the exceptional class of transactions which look prima facie like a supply, but which lose that character when viewed in their context” (paragraph 102).
At first blush, this is a peculiar concept. If something looks like a supply, that must be because it has the characteristics of a supply. In the physical sciences, having the requisite characteristics of a particular group is both necessary and sufficient to belong to that group. For example, the characteristics of a mammal are being warm-blooded, vertebrate, (females) secreting milk to feed their young, and having a four-chambered heart (please do not write in if I have omitted one or more of your favourite mammalian characteristics). Any creature that has all of these characteristics is a mammal. The class of mammals includes humans, whales, bats and rodents. This is a pretty disparate group (it is hard to imagine the social occasion that could happily include them all). Yet there is no question of a creature which looks prima facie like a mammal being disqualified from membership because of where or how it lives (ie its context).
This certainty in the physical sciences is reflected in VAT law by the principle of legal certainty applied by the European Court according to which predictability and consistency are virtues to be borne in mind when construing legislation (save, post-Halifax, in the case of abuse where the underlying law of which the written text is merely a pale shadow may require the written text to be stood on its head).
That the judge in MBNA was troubled by this apparent absence of legal certainty is made clear at paragraphs 107 and 108 of the judgment, where he sets out the factors that gave him “considerable pause for thought”. Ultimately, Mr Justice Briggs overcame his concerns at creating a new class of exception to the general rule that the provision of goods or services for consideration is a supply on the basis that this new class was consistent with the existing classes.
The existing exceptions to the general rule set out by the judge are:
- the sale of currency to a foreign exchange dealer to obtain an exchange service;
- the assignment of debts to a factor to obtain a factoring service; and
- the assignment of property to a lender as security for a loan.
The common factor identified by the judge between these situations and the assignment of debts as part of the securitisation process is that they all constitute “compliance with a necessary condition for the supply of the service by the transferee to the transferor”.
There are also other situations where the provision of goods or services does not constitute the making of a supply. The most common of these is the making of payment; it is the generalised form of the foreign exchange exception set out by the judge. Where a business pays for a supply, it is either providing goods if the payment is in cash or a service of payment if carried out by some other means. However, payment does not constitute a supply (even though there is nothing in the legislation which specifically prevents it from constituting one).
Tenants typically have obligations to keep their leased property tidy and in good order. In some leases, the tenant will have an obligation to decorate and/or refurbish the property on a periodic basis. Plainly, cleaning and decorating can constitute the making of supplies, but not when carried out by a tenant.
Indeed, almost every commercial contract will place a series of obligations on the recipient of the supply in addition to payment (for example warranties, indemnities, and non-compete clauses). Typically, none of these obligations will amount to the making of supplies.
There is a practical reason why activities such as those set out above cannot constitute supplies. This is the impossibility of VAT accounting in such a world. If every transaction constituted multiple supplies made by both parties, chaos would ensue. There would need to be a mechanism for apportioning consideration between the various elements. If a tenant pays rental of £10,000 but also provides a service of keeping the property in good repair, then the total value of the supply or supplies provided by the landlord must be in excess of the £10,000 in order to balance the monetary and non-monetary consideration provided by the tenant. The values of all the “non-core” supplies would need to be determined so that proper invoices could be issued. The single/multiple supply questions that would be generated would be sufficient to make a VAT lawyer drool and business despair. In short, the whole VAT system would be unworkable.
Having established a practical reason why the concept of a supply needs to be kept in check, it is necessary to find a principled underpinning for this. The concept of exceptions to the general rule as set out by the judge is, with respect, not the ideal candidate. If all of the activities set out above constitute exceptions to the general rule, then the general rule is beginning to look far from general, since one or more of these “non-supplies” are likely to accompany every supply.
In fact, the general rule as stated by the judge is not really a general rule at all. This is explicitly recognised by Mr Justice Briggs earlier in his judgment (paragraph 15ff). He cites Article 6 of the Sixth Directive, which states that “‘supply of services’ shall mean any transaction which does not constitute a supply of goods”. He then states that
“[r]ead literally, paragraph 1 of Article 6 would appear to mean that any transaction of any kind (other than a supply of goods) constitutes a supply of services, although pursuant to Article 2 it will only be subject to VAT if effected for consideration. As will appear however, paragraph 1 of Article 6 has not been interpreted with that degree of remorseless logic. Its apparently limitless breadth is circumscribed by reference to the essential nature and purpose of VAT”,
for which point the judge found support in the Opinion of the Advocate-General in Kretztechnik AG v Finanzamt Linz [2005] STC 118 (the case that held that share issues are not supplies).
It is in this inherent limitation on the concept of a supply that the solution to the apparent paradox of limitless exceptions to a general rule can be found. Essentially, in the view of the writer, in order for the provision of services for consideration to constitute a supply, those services must have an independent existence. This immediately eliminates payment for a supply as a candidate for itself being a supply; it is inherently parasitical to the supply for which it is payment. This formulation also properly leaves as supplies both sides of a barter transaction. Although each is payment for the other, each also has an independent existence and purpose of its own. If I provide legal services to a builder in exchange for the builder providing me with construction services, we both have made a supply with an independent existence and purpose. The two supplies are fully independent activities; they are joined together solely by an agreement of both parties to accept the provision of the supply to them in lieu of payment in money by their customer.
This analysis explains why the assignment of an interest in property to a lender as security for a loan is not a supply. It is inconceivable that the assignment would take place without the loan; the assignment is not a separate activity but rather it is part of the architecture of the supply of the loan. The same applies to the obligations of tenants to keep property in good repair or to refurbish. No person would enter into such an undertaking without enjoying the rights of tenancy (although the practical compliance with such obligations entails cleaning and decorating, the obligations themselves are very different from the terms on which cleaners and decorators would contract to provide services).
The assignment of debts is more of a borderline case. The ECJ has held that the assignment of debts to a debt factor is not a supply (Finanzamt Gross Gerau v MKG Kraftfahzeuge Factory GmbH [2003] STC 951). In MBNA, the High Court has held that the same applies to debts assigned as part of a securitisation. However, the assignment of debts in return for consideration can be a genuine and independent commercial and economic activity. The issue in these cases is whether the particular assignment under consideration is made in such a way that, taking into account all of the relevant circumstances, it would not be made were it not for some activity being carried out for the assignor by the recipient of the assignment. The High Court in MBNA appears to have been swayed by the fact that the securitisation structure had been carefully and specifically designed to achieve its purpose of providing lower cost funding; was operated under very detailed contracts; and was carried out precisely in accordance with those contracts. Taken together, these factors persuaded the court that the assignments were too intrinsically bound up in the securitisation to have the necessary independent existence to constitute supplies in their own right.
This analysis has some similarities to the single/multiple supply debate. That is concerned with whether one or more parts of an overall supply so dominate other parts that they lose their independent fiscal identity. A useful metaphor for this test is whether one element of the supply exerts a sufficient gravitational pull to hold other elements in its orbit. Similarly, one can see the test outlined above as whether one supply has a sufficient gravitational pull to draw an activity carried out by the recipient of that supply into its orbit thereby denying that second activity the status of an independent supply.
I would end on a note of caution. It would be nice to think that identifying a test would make it easy to determine where the border between activities that do, and activities that do not, constitute supplies lies. In the world of VAT, this may be unlikely to be the case. Since the ECJ set out its classic summary of the single/multiple test in Card Protection Plan Ltd v C & E Comrs [1999] STC 270, the issue has been before the domestic courts with great frequency and no apparent ultimate resolution. Unfortunately, knowing the question is not the same as knowing the answer and it is likely that there will be many more cases such as MBNA before the boundary between activities that are and are not supplies is clearly established.
1 The detail of this decision and its impact for securitisations was covered in some detail by Peter Jenkins in his excellent article “The VAT Treatment of Credit Card Securitisations” (Tax Journal, Issue 857, October 2006) and the writer does not intend to cover the same ground.
This article was originally published in the December 2006 edition of De Voils Indirect Tax Intelligence, and is republished with permission.