August 25, 2011
Practice Group(s):
Decision in Sight: Is the transfer of
defaulted debts subject to VAT?
Finance
Tax
Encouraging Opinion of the Advocate General from 14th July
2011 in the ECJ Case C-93/10
One of the main controversial points in the context of transactions involving defaulted debts comes
closer to a – hopefully positive – decision:
In his opinion from 14th July 2011 regarding case C-93/10, Finanzamt Essen-Nordost v. GFKL
Financial Services AG, the Advocate General of the European Court of Justice, Niilo Jääskinen,
makes the case for the transfer of defaulted bank debts to a buyer, as well as the acquisition of the
credit risk and debt collection by the buyer, not being subject to VAT. Indeed, he says that typically
the buyer is providing an economic service to the bank. However, with the purchase of defaulted debt
at a discount from the face value which reflects the current market value, there is no remuneration
rewarded by the bank that is directly linked to that service.
The decision from the European Court of Justice on this matter is expected by the end of the year.
Background
The discussion about VAT liability was triggered by the judgement made by the European Court of
Justice in June 2003 regarding M-KG-Kraftfahrzeuge-Factoring-GmbH. The judgement concerned
debt collection by a factoring company. The European Court of Justice decided that a business which
purchases debts, thereby assuming the risk of the debtor’s default, collects the debts and, in turn,
invoices its clients in respect of commission, pursues an economic activity which is subject to VAT.
The German tax authorities have also applied the principles of this judgement regarding factoring to
the purchase of debts for a price at less than face value. They hold that the basis for the assessment for
VAT is the difference between the face value and the purchase price of the debt, less the VAT already
included therein. For “defaulted debts” the so-called economic face value takes the place of the face
value.
Since then the question of how the economic value is assessed and which party should bear any
possible VAT charges has always been part of the agenda when negotiating purchase agreements.
Added to that, the German tax authorities are not bound to the agreements with respect to the
economic face value of the defaulted debt.
Thus, the VAT risk has become one of the major factors for the structuring and calculating of
transactions involving (defaulted) credit debt.
Despite all the criticism, the German tax authorities initially obtained support from the Hesse Finance
Court (Hessisches Finanzgericht) during preliminary legal protection proceedings in May 2007, as the
Hesse Finance Court did not object to the administrative practice.
Decision in Sight: Is the transfer of defaulted debts subject
to VAT?
The Proceedings
The proceedings before the European Court of Justice were triggered by the legal proceedings of
GFKL Financial Services AG against the Finanzamt Essen-Nordost (Tax Authorities for North-East
Essen) held before the Düsseldorf Finance Court (Finanzgericht Düsseldorf). The proceedings
concerned the assignment of defaulted debts by a bank to the plaintiff, for a price below the debt’s
face value. The Düsseldorf Finance Court disagreed with the German tax authority’s practices and
ruled that, for a number of reasons, the collection of defaulted debts does not fall under the scope of
the M-KG judgement. Amongst other reasons, the Düsseldorf Finance Court held that the purchaser
did not render a service to the seller because the collection of the defaulted debt did not constitute an
economic activity on the part of the purchaser. Rather, the purchaser, as the holder of the defaulted
debt, collected for his own interests.
In December 2009, following the appeal of the Finanzamt Essen-Nordost, the Federal Finance Court
(Bundesfinanzhof) finally put the question before the European Court of Justice for a decision. The
Federal Finance Court supported the M-KG judgement in that the purchaser provides a service to the
seller because the seller is released from the collection of debts and the risk of default. However, they
denied that any consideration had been agreed upon and that the consideration was directly linked to
the collection of the debt.
The Opinion
In his opinion from 14th July 2011 the Advocate General essentially subscribes to this view. He also
accepts that with the transfer of bank debts and their collection by the purchaser, the purchaser
provides a service to the seller. He states, however, that this should not apply to debts traded on the
stock exchange or to “pure” assignments, for example in connection with the transfer of business
assets through the sale of an enterprise. The seller acquires the advantage through the transfer of risk
and the collection of bank debts, which exceeds the purchase price, namely, amongst other things, the
possibility to terminate customer relationships and the relief from further legal and public relations
issues connected with the collection of the debts. However, remuneration for this is not directly linked
to the collection. The seller gives the deduction from the face value of the debt because of the drop in
market value, not because the debt is collected from the purchaser.
Even if the deduction were classified as a remuneration – as the Federal Finance Court holds – the
remuneration would not be directly linked to the service. This is to be verified in the case of “Bad
Banks” in each individual case.
In contrast to the Federal Finance Court, the Advocate General denies the prerequisite of a VAT
exemption or the uniform handling as lending. Should the European Court of Justice not follow his
reasonings, he gives further grounds for his decision; with the confirmation of a payment in return for
the service, the basis of assessment for VAT would be the difference between the actual amounts
obtained from the debtors and the purchase price, not the difference between the (economic) face
value and the purchase price. This applies irrespective of the fact that the actual amount is received
after a certain period of time, namely after the collection of the debts. It remains open here at which
point the VAT is to be levied.
The opinion does not contain any express statements regarding non-defaulted bank debts. The
treatment of VAT until now with regard to “true” and quasi-factoring, i.e. where the seller remains
fully liable with regard to the debtor’s ability to pay, is not called into question.
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Decision in Sight: Is the transfer of defaulted debts subject
to VAT?
Outlook
As a rule, the European Court of Justice follows the opinion of the Advocate General. However, it is
not bound to the opinion and has in the past been known to deviate from it.
Whatever decision the European Court of Justice makes, it will most likely increase the legal certainty
for the structuring of future transactions.
Authors:
Rainer Schmitt
rainer.schmitt@klgates.com
+49.69.94.51.96.290
Dr. Christian Büche
christian.bueche@klgates.com
+49.69.94.51.96.365
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