The treatment of credit in EU VAT and an
evaluation of the cash-flow method applied to it
Theodora-Eirini Dimogianni
HARN60 Master Thesis
Tutor
Oskar Henkow
02/06/2014
Academic year 2013-2014
Table of contents
Table of contents .......................................................................................................................................... 2
Abbreviations ................................................................................................................................................ 4
1.
2.
Introduction .......................................................................................................................................... 5
1.1
Background ................................................................................................................................... 5
1.2
Purpose ......................................................................................................................................... 7
1.3
Method and material .................................................................................................................... 7
1.4
Delimitations ................................................................................................................................. 8
1.5
Disposition .................................................................................................................................... 8
Exemptions for credit services .............................................................................................................. 8
2.1
Introduction .................................................................................................................................. 8
2.2
Credit service in the VAT Directive ............................................................................................... 9
2.3
Granting of credit ........................................................................................................................ 10
2.3.1
What is it a granting of credit?............................................................................................ 10
2.3.2
The issue of the identity of the lender ................................................................................ 10
2.3.3
Incidental credit transactions and the right to deduct ....................................................... 11
2.3.4
Credit granting in Leasing ................................................................................................... 13
2.4
Negotiation of credit ................................................................................................................... 13
2.4.1
Definition of credit negotiation .......................................................................................... 14
2.4.2
Applicability of Article 135(1) (b) RVD ................................................................................ 15
2.5
Management of credit ................................................................................................................ 15
2.5.1
The meaning of credit management................................................................................... 15
2.5.2
Case law of credit management ......................................................................................... 16
2.6
Which are the effects of a VAT exempt credit service? .............................................................. 16
2.6.1
A ‘Hidden VAT’ .................................................................................................................... 16
2
2.6.2
3.
Reforms ............................................................................................................................................... 17
3.1
Commission’s Proposals on November 2007 ............................................................................. 17
3.1.1
Background ......................................................................................................................... 17
3.1.2
Proposal for a Council Regulation ....................................................................................... 18
3.1.3
Proposal for a Council Directive .......................................................................................... 19
3.2
4.
Commission’s Proposal on September 2011 .............................................................................. 20
Suggestions for taxing financial services............................................................................................. 21
4.1
Cash-flow method ....................................................................................................................... 21
4.1.1
Introduction ........................................................................................................................ 21
4.1.2
How could the cash-flow method work? ............................................................................ 22
4.2
Cash-flow method with Tax Calculation Account (TCA) ............................................................. 23
4.3
Truncated cash-flow method with a TCA.................................................................................... 24
4.4
How could the cash-flow method operate on the credit services? ............................................ 25
4.4.1
4.5
5.
Distortion of competition ................................................................................................... 17
Granting of credit ................................................................................................................ 25
Evaluation of the cash-flow method applied to credit services ................................................. 30
4.5.1
Granting of credit ................................................................................................................ 30
4.5.2
Negotiation and management of credit ............................................................................. 31
Conclusion ........................................................................................................................................... 32
List of references......................................................................................................................................... 34
3
Abbreviations
AG
Advocate General of the ECJ
CFE
Confédération Fiscale Européenne
DIRECTIVE
Council Directive 2006/112/EC of 28 November 2006 on the common system of
value added tax
EC
European Commission
ECJ
European Court of Justice
EU
European Union
FECMA
Federation of European Credit Management Associations
IBFD
International Bureau of Fiscal Documentation
MS
Member State
PwC
PricewaterhouseCoopers
RVD
Recast VAT Directive 2006/112/EC of 28 November 2006 on the common system
of value added tax
TCA
Tax Calculation Account
UK
United Kingdom
VAT
Value Added Tax
4
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 credit
are 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 complexity on the subject of taxation arises 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, includes also
reimbursement for 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 that money is the consideration for supplies of financial services and
simultaneously is the subject of the transaction, an obstacle is generated for 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 that
the financial services’ VAT exempt status causes several negative consequences. For example,
1
2
3
4
5
6
7
8
Under Article 1(2) RVD
Opinion Statement by CFE, p.1
See Poddar, English (1997), p.90
De la Feria, Lockwood (2009), p.4
PwC Study (2011), pp.24-25
PwC Study (2011), pp.24-25
Opinion Statement by CFE, p.259
Opinion Statement by CFE, p.259
5
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 of
the 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 cascades10, 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. CFE claims that a distortion may arise from 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 option14 and those which do not.15 Under PwC, 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 probably has 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-
9
Ernst & Young Study, pp.19-20
‘’Tax cascading comes as an outcome when a merchandise or a service is taxed for a lot of times under one
specific tax as it passes through several stages of the production-distribution chain, that is to say from the
manufacturing to the retail stage.’’ See International Monetary Fund, Tax Policy Handbook, 1995, p.75
11
Ernst & Young Study, pp.19-20
12
Ernst & Young Study, pp.19-20
13
Opinion Statement by CFE, p.260
14
For instance, countries like Estonia, France, Germany and Lithuania permit financial institutions to decide on for
taxation concerning their exempt financial transactions. See IBFD, VAT Survey, p.7
15
Opinion Statement by CFE, p.260
16
PwC Study (2006), p.42
17
PwC Study (2006), p.13
18
PwC Study (2006), p.13
10
6
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 which plays a vital role to the transactions
between 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
proposals for imposing the VAT on the financial services have been derived from a number of
different methods which 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, to illustrate the merits and demerits of the cash-flow
method and 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 writing this thesis the method which is followed is
the traditional legal. Afterwards, books and articles represent the basic sources 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 and analyze its respective Articles. Moreover, for showing the consequences which
are generated from the current VAT exemptions status and for describing how the suggested
methods could operate for taxing the exempt financial services, various studies from the most
important multinational companies to the financial advisory part, as for instance are PwC and
Ernst & Young, are used as a precious spring for the integration of this purpose. Finally, a
number of cases from ECJ are utilized for investigating and thus understanding in which way the
granting, negotiation and management of credit are faced respecting VAT within the EU
economy.
19
PwC Study (2006), p.13
7
1.4 Delimitations
As it has been previously reported, the subject of discussion in this thesis is the VAT treatment
of the credit services within EU. For the thesis correct analysis, it is comprehensible that there
have to be specific delimitations. First of all, there won’t be any reference to the way that the
credit services are handled outside of the Community. Then, there won’t be any analysis of how
the rest financial services, except granting, 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 examined any other forms of tax which are relevant with the financial services, as for
instance is the 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 be the only method 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, their VAT treatment, the reasons which have kept these
services from not being taxed under the normal credit invoice system and the respective
consequences of this VAT 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 exemption condition. Thereafter, the third chapter
covers the Commission’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 the cash-flow
method which is suggested for taxing the financial services and more specifically there is an
assessment of it as 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 services in EU and its
suggested solutions are included.
2. Exemptions for credit services
2.1 Introduction
8
The notion of credit derives from the Latin word credere which 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 a direct payment.20
In the EU economy, concerning the transactions which take place between the financial and
non-financial businesses with their customers, credit is a core economical service. It facilitates
businesses or consumers for effectively settling up their economic obligations which have
arisen as a result from their purchases. The customers can request for a delay on their
payments even for very small amounts and short terms of period.
The actions of negotiation and management of credit are considered to play an important role
for the successful integration of the credit granting. Occasionally these three services can 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 to the granting
and to finish again with 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 management
to negotiation.
2.2 Credit service in the VAT Directive
On the subject of the VAT for credit, 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 applied can cause
various negative consequences, in several cases it was stated by 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 are specific 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
Concerning the 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
20
21
22
23
Andersson (2001), p.9
Case C-348/87 Stiching, paragraph 13; Case C-2/95 SDC, paragraph 20
KPMG, European Leasing, p.11
See Article 168 RVD
9
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
provide VAT exempt financial services including credit within the Community, they are not
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 nonrecoverable tax is a remarkable source of revenue for the governments of the Member States.25
2.3 Granting of credit
2.3.1 What is it a granting of credit?
Granting of credit can be characterized as the economical 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 enterprise makes available the amount of loan which the
customer requests and secondly, when a non-financial undertaking accepts for 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.’
2.3.2 The issue of the identity of the lender
In ECJ case law with reference to the credit granting, the subject of the identity of the lender
was a remarkable issue of dispute and for this reason a deeper interpretation of the expression
‘by the person granting it’ which is stated in Article 135(1) (b) RVD was needed.
In the Muys case27, 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
24
25
26
27
Under Article 169(c) RVD
Commission Staff Working Document, p.2
Directive 2000/35/EC, L 200/36, paragraph 16
Case C-281/91 Muys
10
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 discrimination and thus a distortion in the competition. Then, with
regard to the interest paid as reward for the granting of credit, the Court issued that where a
supplier of goods or services had granted his customer deferral of payment of the price, in
return for payment of interest only until delivery, that interest did not constitute consideration
for the grant of credit 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
required invoice’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 also argued in SDC case29 but regarding the occasions where
points (d) and (f) of Article 135 (1) RVD were implemented. The ECJ issued that the 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 services had 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.
2.3.3 Incidental credit transactions and the right to deduct
The credit with the form of a loan granted from a holding company to its subsidiaries was
discussed in the EDM case30. In this occasion, the issue was if the credit granting constituted an
economic activity and then if 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
28
29
30
31
Opinion of AG F.G. Jacobs in case Muys , paragraph 10
Case C-2/95 SDC, paragraph 33
Case C-77/01 EDM
Opinion of AG Léger in case EDM, paragraph 46
11
by that holding company in bank deposits or in securities, constituted economic activities
carried out by a taxable person and so as financial transactions were VAT exempted. From my
view, the ECJ correctly expressed that the holding company provides a financial service that is
to say, grants credit which is VAT exempt since it facilitates economically its subsidiaries not
free of charge but with exchange a specific interest. Afterwards, in this case another important
matter was the deduction of VAT. The Court stated that for calculating the deductible
proportion and so if the services had to be excluded from the computation under Article 174(2)
(b) RVD32, were to be regarded as ‘incidental transactions’ thereof in so far as they involved
only very limited use of assets or services subject to VAT.
Similar questions like these which were stated in the EDM case with regard to the definition of
the ‘economic activity’ and the computation of the deductable VAT arose also in case
Floridienne and Berginvest33. The Court held that the loans which were granted by a holding
company to its subsidiaries did not constitute an economic activity of that holding company.
Consequently, the interest paid as remuneration had to be excluded from the denominator of
the fraction used to calculate the deductible proportion. The ECJ here operated exactly the
opposite from the EDM case. Its decision of not characterizing as economic activity the granting
of credit, it shows how complex and simultaneously crucial is to righty judge so as to not arise
any discriminations between the enterprises.
Afterwards, in the Régie case34 the main question was if the receipt of interest from the
placements by property management companies from lessees’ advances constituted or not the
direct, permanent and necessary extension of the taxable activity of these companies. The
Court finally decided that it constituted the permanent and essential extension and that such
placements couldn’t be characterized as incidental financial transactions within the meaning of
Article 174(2) RVD. Consequently, they couldn’t be excluded from the calculation of the
deductible proportion of VAT.
The question why the incidental financial transactions have to be excluded from the
denominator of the fraction which is used to calculate the deductible proportion was answered
in the Nordania Finans A/S case35. The ECJ held that the main goal is to comply with the
objective of complete neutrality guaranteed by the common system of VAT. The justification for
this statement was that if all receipts from a taxable person’s financial transactions linked to a
taxable activity were to be included in that denominator, even where the creation of such
32
Article 174(2) (b) RVD states that ‘’…the amount of turnover attributable to incidental real estate and financial
transactions, shall be excluded from the calculation of the deductible proportion.’’
33
Case C-142/99 Floridienne and Berginvest
34
Case C-306/94 Régie, paragraph 22
35
Case C-98/07 Nordania Finans A/S, paragraph 23
12
receipts did not entail the use of goods or services subject to VAT or, at least, entailed only their
very limited use, calculation of the deduction would be distorted36.
In the Bausystem case37 was discussed the inclusion to the basis for the turnover tax
assessment of an interest which was imposed on account of late payment. ECJ agreed with AG
Rozès and declared that the basis of assessment referred to in Article 78 RVD38, did not include
interest awarded to an undertaking by a judicial decision where such interest had been
awarded to it by reason of the fact that the balance of the consideration for the services
provided had not been paid in due time. It seems that ECJ properly stated that the interest
could not be included to the tax basis, since it wasn’t the payment for instance for an additional
service e.g packing or transport for the primary service. It was the remuneration for the
deferral of payment and according to Article 135(1) (b) RVD had to be VAT exempt.
2.3.4 Credit granting in Leasing
The occasion of a supply of credit vis-à-vis the customer was faced in the Auto Lease Holland
case39. The supplier called Auto Lease offered the lessee the option inter alia of entering into a
fuel management agreement with it. So, the agreement permitted the lessee to fill up his
motor vehicle with fuel in the name and at the expense of Auto Lease. The lessee had to pay to
Auto Lease each month in advance one twelfth of the likely annual petrol costs. At the end of
the year, the account was settled up according to the actual consumption. Additionally, there
was a supplementary charge for fuel management. As AG Léger40mentioned, the company
acted like any finance or credit institution and its role could not be distinguished from that
played by the credit card company, which nobody claimed was in receipt of fuel. ECJ declared
that the fuel management agreement was not a contract for the supply of fuel, but rather a
contract to finance its purchase. Auto Lease acted as a supplier of credit vis-à-vis the lessees
and received a specific payment relating to its services.41 The Court rightly declared that this
transaction constituted a granting of credit since this action completed the most basic
characteristic of credit, the deferral of payment in exchange for an interest paid by the
customer.
2.4 Negotiation of credit
36
Case C-306/94 Régie, paragraph 21
Case C-222/81 Bausystem
38
Article 78 RVD states that: ‘’The taxable amount shall include the following factors: a) taxes, duties, levies and
charges excluding the VAT itself and b) incidental expenses such as commission, packing, transport and insurance
costs, charged by the supplier to the customer’’
39
Case C-185/01 Auto Lease Holland
40
Opinion of AG Léger in case Auto Lease Holland, paragraph 30
41
Henkow (2007), p.96
37
13
2.4.1 Definition of credit negotiation
Negotiation of credit is an action of intermediation which is completed usually before and
sometimes after the granting of credit. During the procedure of the negotiation before the
granting, the supplier discusses and tries to reach to a deal with the customer concerning the
amount of the credit, the number of credit days, the interest and the way of settling up the sum
e.g installments. After the granting, if the customer hasn’t been consistent with his/her
obligations there is always a possibility for a second negotiation to start for treating the credit
terms in a new basis.
A further analysis of the expression ‘negotiation of credit’ is given by the CSC Financial Services
case42. As the Court stated, the negotiation is an action of mediation, which may consist,
amongst other things, in pointing out to one of the parties to the contract suitable
opportunities for the conclusion of such a contract, in making contact with another party or
negotiating, in the name and on behalf of a client, the detail of the payments to be made by
either side, the purpose of such an activity being to do all that is necessary in order for two
parties to enter into a contract, without the negotiator having any interest of his own in the
terms of that contract.
Another case which had referred to the term of credit negotiation was the Ludwig case43. The
ECJ stated that when a taxable person has analyzed the financial situation of some clients
canvassed by him with a view to obtaining credit for them, did not preclude recognition of the
service supplied as being a negotiation of credit which is exempt under Article 135(1)(b) RVD, if
the negotiation of credit offered by that taxable person fell to be considered as the principal
service to which the provision of financial advice was ancillary, in such a way that the latter
shared the same tax treatment as the former. Additionally, ECJ mentioned that for
characterizing a service as credit negotiation and thus to be VAT exempt, it wasn’t mandatory
for the supplier to have a contractual link with any of the parties in the credit agreement. The
Court through this decision tries to ensure again the equality between the undertakings that
are linked to the parties of the agreements and those which are not.
According to ECJ in DTZ Zadelhoff case44, the precise meaning of the word ‘negotiation’ which
appeared in Article 135(1)(b) to (e), it wasn’t mandatory to be taken into consideration so as to
show that the context of Article 135(1)(f) RVD was referring to another interpretation of this
term. It was declared that negotiation was the activity of an intermediary who did not occupy
the position of any party to a contract relating to a financial product, and whose activity
42
43
44
Case C-235/00 CSC Financial Services, paragraph 39
Case C-453/05 Volker Ludwig
Case C-259/11 DTZ Zadelhoff, paragraph 27
14
amounted to something other than the provision of contractual services typically undertaken
by the parties to such contracts. It was a service rendered to, and remunerated by, a
contractual party as a distinct act of mediation.45
2.4.2 Applicability of Article 135(1) (b) RVD
The direct applicability of Article 135(1) (b) RVD was the main issue in the Becker case.46 In
particular, the dispute was for the Germany’s delay to apply the VAT exemption status for the
negotiation of credit. For granting and management, Germany had already complied with the
rules. As AG SIR Gordon Slynn correctly declared47, the question was not whether the directive
was "directly applicable" but whether its terms were such that the individual could rely upon it
against the MS who in breach of duty had failed to implement it. Finally, the ECJ stated that as
from 1 January 1979 it was possible for the provision concerning the exemption from turnover
tax of transactions consisting of the negotiation of credit contained in Article 135(1) RVD to be
relied upon, in the absence of the implementation of that directive, by a credit negotiator
where he had refrained from passing that tax on to persons following him in the chain of
supply, and the State could not claim, as against him, that it had failed to implement the
directive.
2.5 Management of credit
2.5.1 The meaning of credit management
Management of credit is the procedure, after the negotiation and before the granting of credit,
which includes the checking of the customer’s essential documents that can verify his/her
financial condition and therefore to reduce or even better to eliminate the risk of not settling
up the loan in the end. Management of credit is also applied after the granting with the
intension of ensuring that the process of payment is successfully completed and that there is no
late payoff. Generally, several types of management exist. ‘A centralized management of credit’
is one suggested form with the purpose of facilitating the situation where companies with an
existing network of international subsidiaries have a variety of credit management systems in
place and they are not always capable of communicating with each other, resulting in
additional costs and inconsistent data sets.48
45
46
47
48
Opinion of AG Sharpston in case C-44/11 Deutche Bank AG, paragraph 37
Case C-8/81 Becker, p.56
Opinion of AG Sir Gordon Slynn in case Becker, p.80
FECMA Magazine, p.25
15
2.5.2 Case law of credit management
The credit management is an important financial service. With the intention of understanding
how it is treated generally in EU, the ECJ case law has to be analyzed. Unfortunately for this
credit service we cannot find a lot of cases. As Oskar Henkow mentioned, the ECJ has made one
comment for this credit service in the SDC case49. In this occasion the Court stated that, the VAT
exemption had to be applied for the management of loans only if those operations firstly were
separate in character and secondly specific to and essential for the appropriate and successful
function of the exempt transactions. Nevertheless, as the management is only exempt when
the person granting the credit is exempt, management provided by other persons is normally
taxed by the credit invoice system.50
2.6 Which are the effects of a VAT exempt credit service?
2.6.1 A ‘Hidden VAT’
As we observed before51, the fact that the financial services are not taxed can generate several
problems. The effects of the VAT exemptions for the credit services are reflected in different
ways. First of all, the problem of the ‘hidden VAT’ and which are its consequences is illustrated
by EC.52 For example, a bank grants credits which are exempt according to Article 135(1) (b)
RVD to taxable persons (business clients) and to non-taxable persons (private consumers). The
VAT which the bank pays on consultancy for developing the whole structure of the credit
cannot be deducted by the bank and thus becomes a part of its overall costs. With regard to the
private consumers, the fee for the credit services which the bank supplies, contains this input
VAT. Nevertheless, this situation is more than compensated by the fact that the banks’ supplies
are also provided without VAT. Similarly, the price for the credit services which the bank
supplies to business consumers also includes this input VAT. The point is that if these credit
services were taxed, the business client could have the opportunity to deduct the VAT.
Consequently, the non-deductible VAT contained in the price of the credit service is an
operating cost for the bank's business client and as a result the business will invoice VAT upon
VAT when it supplies its goods or services.
In ECJ case law, the problem of the non-recoverable VAT relating to the credit services was
illustrated by Newey case53. In this occasion was reflected the effort by Mr. Newey to solve the
problem of the non-recoverable VAT. The loan broking services supplied by him in the UK were
49
50
51
52
53
Case C-2/95 SDC, paragraph 77
Henkow (2007), p.99
See Chapter 1.1
EC Consultation Paper, p.6
Case C-653/11 Newey
16
in accordance with Article 135(1) RVD VAT exempt. By contrast, the advertising services
supplied to him in the UK, were subject to VAT with the result that the tax borne on the
advertising costs was not recoverable. In order to avoid that non-recoverable tax burden, he
incorporated a company in Jersey, a territory in which the Sixth Directive did not apply. Thus,
the broking contracts were concluded directly between the lenders and the company in Jersey.
The ECJ stated that it was conceivable that the effective use and enjoyment of the services at
issue in the main proceedings took place in the UK.
2.6.2 Distortion of competition
In some occasions the problem of the ‘hidden VAT’ can result to a distortion of competition. For
instance in the Newey case, it seems that Mr. Newey had the idea of establishing a second
company to one country where the Directive didn’t apply, with only goal to deduct the input
VAT. Probably a lot of enterprises have already thought in the same way as was described in
Newey and from the State’s perspective it can be sometimes very difficult to ascertain the cases
if someone does it with sole purpose to avoid the burden of the non-recoverable VAT or not.
However, if the State cannot find these cases, then a distortion in the competition can easily
arise. An example could be the case where companies ‘A’ and ‘B’ are in the same country and
they are both supplying credit services. Then, company ‘A’ regarding its expenses, decides to
establish a second enterprise to another country with only goal to achieve the deduction of
input VAT from its transactions. This would be totally unfair for company ‘B’ which won’t have
the opportunity of deducting the VAT and will shoulder this burden. Consequently, company ‘B’
will be in a less favorable economical situation in comparison with company ‘A’.
3. Reforms
3.1 Commission’s Proposals on November 2007
3.1.1 Background
The Commission has actively pursued the modernization of the financial services VAT regime
since early 2006, when it commenced a public consultation process and engaged PwC to study54
the economic effects of the VAT system as it applied to the financial and insurance services. The
Commission recognized that the VAT exemptions, largely drafted in the 1970s, were no longer
fit for purpose in the current global financial marketplace. Furthermore, the PwC study
concluded that EU financial services enterprises were in a point less profitable than their non-
54
PwC Study (2006)
17
EU equivalents (such as United States undertakings), and that important embedded VAT costs
might contribute to this difference in profitability.55
In November 2007 following a lengthy consultation procedure initiated in the wake of the ruling
from the Court of Justice in Accenture case56, the EC presented two proposals.57 More
specifically, on 28 of November 2007 the Commission presented its Proposal for a ‘Council
Directive amending Directive 2006/112/EC on the common system of VAT, as regards the
treatment of insurance and financial services’58 together with the Proposal for a ‘Council
Regulation laying down implementing measures for Directive 2006/112/EC on the common
system of VAT, as regards the treatment of insurance and financial services’59.60
3.1.2 Proposal for a Council Regulation
The objectives of this proposal were to increase the legal certainty for economic operators and
national tax administrations, while reducing their administrative burden for correctly applying
the rules for the VAT exemption of insurance and financial services and reducing the impact of
‘hidden VAT’ in costs of insurance and financial services providers.61 According to Commission,
the objectives of this proposal could be achieved by breaking down the concept and the
conditions stipulated in Article 135(1) (a) to (g) and (1a) and in Article 135a of Directive
2006/112/EC to specific economic scenarios. This would result in non-exhaustive enumerations
of cases for which the Regulation stipulated that they were either covered by the exemption
from VAT for insurance and financial services or excluded from it. 62
In fact, in many cases economic operators needed fiscal advice from independent consultants
and often had to verify in burdensome and lengthy negotiations with national ministries of
finance, whether a specific service supplied was or was not covered by the VAT exemption.
Local tax administrations also had to bear high administrative charges for clarifying with the
national ministries of finance how they had to proceed in specific cases. In those cases where
the Regulation provided a clear solution, economic operators and administrations would be
able to apply the exemption from VAT for insurance and financial services correctly without this
burden being involved. 63
55
56
57
58
59
60
61
62
63
PwC (2007), p.1
Case C-472/03 Arthur Andersen
De la Feria, Lockwood (2009), p.2
COM (2007) 747 final
COM (2007) 746 final
Terra (2010), pp.1-2
Terra (2010), pp.1-2
COM (2007) 746, p.2
COM (2007) 746, pp.2-3
18
For intermediation in insurance and financial services the proposal could only provide a clear
solution in a limited number of cases. This was due to the fact that the concepts and forms of
intermediation were very much rooted in national civil laws and therefore varied substantially.
To improve legal certainty also with regard to such services, the Regulation additionally
specified objective criteria to be applied in evaluating whether a service represented a distinct
act of mediation.64
The Council of the European Union adopted this Regulation where in Article 3 the definition of
the "granting of credit" had to cover for instance, credit arrangements under which a person
was entitled to dispose of funds up to a fixed amount and loans secured on real property,
including mortgage loans.65 On the other hand, firstly the granting of credit in connection with
hire purchase and lease purchase agreements where the consideration for the credit
constituted an integral part of the consideration for the hire and lease purchase and secondly
agreements under which payments by installments or an extended period for payment, were
provided for the supply of goods or services had to be excluded from the definition of ‘granting
of credit’. Additionally, valuation of non-financial collateral and the issuance of credit
derivatives were transactions which under Article 15 had to be considered to have the specific
and essential character of ‘granting of credit’.66
3.1.3 Proposal for a Council Directive
The objectives as have already been mentioned in the proposal for a Council Regulation could
have been achieved by the three following measures : clarification of the rules governing the
exemption from VAT for financial services, broadening of the existing option for taxation by
transferring the right to opt from the Member States to the economic operators, introduction
of a cost-sharing group which would allowed economic operators to pool investments and redistribute the costs for these investments exempt from VAT from the group to its members.67
The clarification of the rules governing the exemption from VAT for financial services had the
objective to provide a more uniform application of the VAT exemption, creating more legal
certainty for economic operators and reducing the administrative burden for economic
operators to comply with the rules. This clarification consisted of the following elements: a) the
conditions for applying the VAT exemption were based on objective economic criteria
decoupling them from an interpretation based on national private law concepts, which was one
of the main reasons for different interpretation and application in the Member States. These
objective economic criteria ensured that also new services which would have been developed
64
65
66
67
COM (2007) 746, pp.2-3
COM (2007) 746, Article 3
COM (2007) 746, Article 15
COM (2007) 747, p.2
19
in the future would be covered by the VAT exemption if they have fulfilled these criteria, b) the
new rules introduced the concept that the exemption had to cover the supply of any
constituent element of a financial service, which constituted a distinct whole and had the
specific and essential character of the exempt service concerned, c) a common harmonized
concept of intermediation was introduced for insurance and financial services, d) where this
was possible, the new definitions also created more consistency with internal market rules (e.g.
investment funds).68
Then, under the broadened option for taxation, it would be the economic operator who
decided if he wanted to be fully taxable and where he was exercising this right, he would be
able to deduct input VAT on his investments like any other economic operator. In this way a
level playing field for the financial industry was created that was not achieved so far as only
very few Member States have granted the option to business and this under differing
conditions. At the same time Member States were given the necessary flexibility to specify
themselves the rules for applying that option, adapting it to their national tax supervision
structures. Additionally, under the proposed cost-sharing model, in particular smaller economic
operators could pool their investments in groups which could buy these investments at better
market conditions and re-distribute them exempt from VAT to the members of the group.69
3.2 Commission’s Proposal on September 2011
‘The VAT amendment Directive on insurance and financial services is vitally important not only
for the creation of a single and effective European market for insurance and financial services,
but also to ensure that EU businesses are not put at a disadvantage to their non-EU
competitors. Over the last years, considerable effort has been expended by the EC, different
Presidencies and Member States’ negotiation teams in an attempt to arrive at legislation that
clearly defines which insurance and financial services should be exempt from VAT. The latest
definition of exempt services on 2011 is not, however, sufficiently robust. It will not keep pace
with new developments within the insurance and financial services sector or create legal
certainty for Members States and businesses, nor will it remove actual, or potential,
competitive distortions between insurance and financial services supplied across different
Member States, and between EU and non-EU businesses. Given the importance of the issues at
stake and the considerable effort expended on the review, it would be unfortunate if any new
Directive were found to be inadequate on or within a few years of adoption by the Member
States.’70
68
69
70
COM (2007) 747, p.2
COM (2007) 747, p.3
Comments by the European Association of Co-operative Banks (EACB), the European Association of Public Banks
20
‘According to the Proposal for a Council Directive amending Directive 2006/112/EC on the
common system of value added tax, as regards the treatment of insurance and financial
services on 30 September 201171 and particularly under Article 1, the Article 135 of Directive is
amended as follows: Regarding the credit, it is exempt the granting of credit and management
of credit by the creditor and not ‘by the person granting it’. Granting of credit means the
lending of money or the promise to lend money, as well as the granting of a deferment of
payment of a debt [, provided that the consideration for granting the credit and the grounds for
determination the consideration are separately identified]. Furthermore, ‘’intermediation in
insurance and financial transactions’’ means a distinct act of mediation rendered by a third
party who [brings the parties together and] does what is necessary in order for the parties to
enter into, maintain, renew or alter a contract in insurance or financial transactions as referred
to in points (a) to (gb) of the Directive.’72
4. Suggestions for taxing financial services
4.1 Cash-flow method
4.1.1 Introduction
As it has already been mentioned, the fact that most of the financial services are VAT exempt
can cause a lot of complications. For this reason, various methods have been proposed for
entering the exempt financial services to the credit invoice VAT system. The cash-flow approach
is one of them and is characterized as the most adequate for this purpose.
Initially the method appeared as another form of VAT and as a substitution for the firms’
income tax (Meade 1978).73 Later in 1987, it was for the first time suggested as a method for
calculating the VAT for the exempt financial services provided by a financial institution.74 The
cash-flow method would apply only to these financial services where the consideration is
implicit and hidden in the margin on the exchange of funds.75 The method wouldn’t be
implemented for the financial services where their remuneration is explicit because these
(EAPB), the European Banking Federation (EBF), the European Fund and Asset Management Association (EFAMA),
Insurance Europe (formerly the CEA) and the European Federation of Insurance Intermediaries (BIPAR) on the EC’s
proposal to reform the VAT rules applied to financial and insurance services, p.1
71
COM(2011)
72
COM(2011), p.6
73
Poddar, English (1997), p.90
74
‘’The best known solution to the ‘dividing the value added’ problem was proposed initially by Hoffman, Poddar
and Whalley (1987) and Barham, Poddar and Whalley (1987) and later developed by Poddar and English (1997) via
the use of a cash-flow tax’’. De la Feria, Lockwood (2009), p.5
75
Poddar, English (1997), p.91
21
would be treated in the same way as the non-financial services under the credit invoice VAT
system.76 A significant issue that the cash-flow method is focusing on is the successful
compliance with the basic principle that VAT is estimated on each transaction separately. The
supporters of the cash-flow method claim that after all the relevant estimations it could be
feasible to have exactly the same results as it was possible for a financial institution to estimate
the value added for each transaction, to impose the relevant VAT and so the respective firms
liable for VAT, to claim a refund or a deduction of the input tax.77
A number of merits are the main reason for determining the cash-flow method as the most
appropriate mechanism for imposing VAT on the financial services. The elimination of tax
cascading is one of the positive results that occur, since the registrants who accept the financial
services are able to claim for a refund or a deduction of the input tax regarding the cash
outflows and are obliged to pay the tax on the cash inflows.78 Moreover, the fact that the
financial institutions don’t impose VAT to their transactions with the non-residents helps
notably the institutions to be in a similar or in a better position in comparison with their
competitors.79
4.1.2 How could the cash-flow method work?
The cash-flow method could operate in a very convenient way for taxing the financial services
of a capital nature. A cash-flow system has two types of flows, that is to say the cash inflow and
outflow. When a financial institution accepts money, a cash inflow takes place and when it
takes out money of its accounts, a cash outflow occurs.
Concerning the cash inflow, it is presumed that the institution has supplied taxable sales and
the amount received is its reward. So, an output VAT will be imposed and have to be paid to the
State.80 Relating to the cash outflow, it is assumed that the institution takes out money of its
accounts for paying a service rendered to it or for a good that is purchased by it. 81 Therefore,
the cash outflow has to be considered as the amount of settling up a taxable financial purchase
and an input VAT is going to be imposed on it. Thus, the institution can claim an input tax credit
for this purchase.82 The spread between the cash inflow and outflow reflects the value added of
the financial services supplied by the financial institution to the registrants.83
76
77
78
79
80
81
82
83
Ernst & Young Study, p.76
De la Feria, Lockwood (2009), p.5
Poddar, English (1997), p.97
Poddar, English (1997), p.97
Henkow (2007), p.323
Henkow (2007), p.323
Henkow (2007), p.323
Henkow (2007), pp.322-323
22
The cash-flow method simplifies the procedure of taxing the financial services by precluding
particular transactions from its tax base. According to the survey of Ernst & Young one instance
of financial transaction that is excluded is with the shareholders/owners of a business. Cash
inflows from the issuance of shares won’t be treated as taxable sales and cash outflows from
dividends won’t be handled as taxable purchases.84 Another exception relates to the financial
transactions between non-financial businesses and non-registered persons and among nonregistered persons. The reason for precluding these transactions is not to attribute credit tax
with regard to a loan from a private individual, where the individual is not registered and does
not pay tax to the State.85
4.2 Cash-flow method with Tax Calculation Account (TCA)
The basic cash-flow method has been proposed as a suitable solution for entering the exempt
financial services to the normal VAT system. However despite its merits, it presents a few
difficulties. In particular, regarding transactions where margin services include cash flows of a
capital nature, one problem appears when the borrower receives a loan from a financial
institution. The borrower has to pay the respective tax imposed on this cash inflow at the
moment of receiving the loan and thus his economical obligations are increased significantly.86
Moreover, another problem shows up when a tax rate changes because it cannot be imposed a
different rate to the cash inflow from this one utilized on the cash outflow.87 An additional
difficulty is any probable adjustments at the beginning of the system.88 In order for these
problems to be handled successfully a new method has been suggested, the cash-flow method
with the usage of a tax calculation account.
The TCA is a temporary tax account which has as a basic aim to defer the payments and credits
of tax. It keeps a record of all the tax obligations from the State’s and taxpayers’ perspective for
a specific time period where the cash flows of a capital nature take place. 89 The account is
debited by the taxes imposed on the cash inflows and is credited by the input tax credits on the
cash outflows related to a financial instrument. The TCA transfers these tax data to the next
period where reversed transactions happen. In the end the spread between the tax attributable
and the credit tax presents the net value which is subject to interest charges at the government
borrowing rate and is payable or refunded periodically.90
84
85
86
87
88
89
90
Ernst & Young Study, p.80
Ernst & Young Study, p.81
Poddar, English (1997), p.98
Poddar, English (1997), p.98
Poddar, English (1997), p.98
Ernst & Young Study, p.103
Ernst & Young Study, p.103
23
The fact that the TCA allows a deferral on tax payments and credits on capital transfers, leads
to a decrease of the cash-flow calculations complexities. This constitutes one of the cash-flow
method’s with TCA significant advantages.91 Furthermore, a second merit is the reduction of
government’s risk regarding the tax deferrals. This is achieved because tax payments on cash
inflows which happen in the first period are assumed to be reversed by the tax credits on cash
outflows in the second period.92
Nevertheless, there are some disadvantages which come from the implementation of this
method. A characteristic demerit is the notable compliance cost which the non-financial
enterprises face in order to have an access to the input tax credits. This cost is caused by the
estimations and keeping the record of debit and credit entries in the TCA for the financial
transactions.93 Moreover, an additional disadvantage derives from the indexing rate which is
utilized for taxing the net balance. This rate is by design lower than the loan interest rate and
thus an input tax credit is always being derived by the system’s tax computations which include
the loan cash flows with unregistered persons.94
4.3 Truncated cash-flow method with a TCA
Several complexities which are relevant with the usage of the basic cash-flow method are faced
successfully with the assistance of the cash-flow method with TCA. Notwithstanding, the
difficulties and the high cost that the non-financial small-medium sized companies face
regarding the completion of their cash-flow calculations, constitute an unsolved problem. The
truncated cash-flow method with TCA suggests the manner of solving this complication.
According to the truncated cash-flow method, VAT would be imposed to financial services
provided for a fee or commission, on the profit margin on financial instruments acquired by a
financial institution for the purpose of resale and on the interest spread on deposits and loans
by financial institutions.95 The truncated cash-flow method with TCA, exploit the fact that the
financial institutions’ cash-flow calculations reflect the businesses’ cash-flow estimations. Thus
since there is no necessity for completing the same calculations twice, the suggestion is only
the financial intermediaries to complete the relevant cash flow estimations which are
required.96 With the usage of the truncated cash-flow method, the financial intermediary could
complete the TCA estimations by issuing a periodical statement regarding the input tax credit
which is claimable by the business registrants. With the exception of the indexing adjustment,
91
92
93
94
95
96
Ernst & Young Study, p.107
Ernst & Young Study, p.107
Ernst & Young Study, p.114
Ernst & Young Study, p.115
Ernst & Young Study, p.117
Poddar, English (1997), p.107
24
the TCA entries would equal the tax rate multiplied by the entries in the deposit or loan
account. The final statement on the basis of the TCA estimations operates in the same way as a
tax invoice for non financial goods and services.97
The difficulties which are relevant with the truncated method are similar to those which exist
with the cash-flow method with TCA. An additional complexity is the lack of input tax credits
respecting bearer transactions with financial institutions.98 However despite its few difficulties,
the truncated cash-flow method with TCA has been characterized as an ideal method for taxing
the financial services because it has similar results like the basic cash-flow method’s and
provides a successful response to the various fundamental difficulties which are generated.99
4.4 How could the cash-flow method operate on the credit services?
4.4.1 Granting of credit
A loan provision is a type of credit granting where the remuneration for this service is implicit
and hidden in the profit margin. For demonstrating how the cash-flow method could operate,
three different situations are analyzed where a bank will be the intermediate which provides
economical services to a depositor and a borrower. For simplifying the examples’ analysis and
their between comparison it is very convenient to utilize illustration 1, which contains a mutual
set of assumptions concerning the deposit and loan interest, the government rate, the VAT rate
and the value of services provided to the depositor and the borrower.100
Illustration 1 Common set of assumptions
Deposit Interest
Loan Interest
Pure Rate of Interest=Interest earned by Government
Value of services to depositor
Value of services to borrower
Total value of financial service
VAT Rate
5%
14%
11%
6%
3%
9%
10%
A. Consumer depositor - consumer borrower
In this example we have an occasion where both the depositor and borrower are consumers,
that is to say they are not liable for VAT. The cash-flow method would function effectively in
taxing the granting, only if the tax is eventually calculated on the value added of the financial
97
Poddar, English (1997), p.107
Ernst & Young Study, p.120
99
Poddar, English (1997), pp.107-108
100
Poddar, English (1997), p.93
98
25
service provided to both of them, as they reflect the notion of the personal consumption.101 As
it is observed by illustrations 2 and 3, in period 1 the bank receives the amount of 100€ from
the depositor. This cash inflow automatically leads to a VAT of 10€ (10% * 100) which the bank
has the obligation to remit to the State. However, in the same time period the bank grants loan
of 100€ to the borrower and this cash outflow generates for the bank the right to claim an input
tax credit of 10€. As a result for this time period, the government won’t gather any tax revenue
and thus no tax implications will arise for the bank.102
Period 1
Illustration 2
Deposit- Credit granting
Bank
100
100
Depositor
Borrower
Illustration 3 Bank’s cash-flow system/ tax implications
Cash inflow (+)
Cash outflow (-)
Subtotal
Deposit= 100
Granting of loan= -100
0
Tax
Credit
Subtotal
Tax on deposit= 10
Credit tax on loan= -10
0
In period 2, as it is shown by illustrations 4 and 5 below, the borrower repays the loan and the
depositor withdraws the deposit. These cash inflow and outflow of the same amount, lead to
zero tax revenue and in non-existent tax liabilities for the financial institution. Besides these
transactions, the bank additionally gets from the borrower an interest of 14€ which generates
an attributable tax of 1.4€ and pays to the depositor an interest of 5€ which implies an input tax
credit of 0.50€ (5% * 100). The spread between the interest received and that paid, reflects the
total value added for the supply of the financial services to both the depositor and borrower,
that is to say (14-5) 9€.103 With reference to the tax obligations which show up, the bank has to
101
102
Poddar, English (1997), p.93
Poddar, English (1997), p.94
103
Poddar, English (1997), p.94
26
remit to the State the amount of 0.90€. The final tax comes as a result from the credit tax on
the deposit interest which is subtracted from the tax imposed on the loan interest. In other
words it results if the value added is multiplied by the VAT rate. As a conclusion, it is
demonstrated that the cash-flow method operates appropriately in this case, since the tax of
0.90€ reflects the VAT imposed on the supply of services provided to both the depositor and
borrower.104
Period 2
Illustration 4 Loan repayment- Deposit withdrawal (plus interest)
Bank
100+14
100+5
Borrower
Depositor
Illustration 5 Bank’s cash-flow system/ tax implications
Cash inflow (+)
Loan repayment= 100
Cash outflow (-)
Deposit withdrawal= -100
Total
0
Loan Interest= 14
Deposit interest= -5
9
Tax
Tax on loan repayment= 10
Tax on loan interest= 1.4
Credit
Credit tax on deposit withdrawal= -10
Credit tax on deposit interest= - 0.5
Total
0
0.9
B. Consumer depositor - business borrower
In this instance, the depositor is a consumer and the borrower is a business entity. For
estimating the total VAT on the financial services provided, the business’s and bank’s cash flows
are both analyzed because now tax consequences arise for both of them. In this example, the
cash-flow method would operate correctly if a net tax is to be received only on the value added
of the service supplied to the depositor. This is justified by the fact that only the depositor
symbolizes the personal consumption.105 In period 1, as it has already been referred in example
A, the bank’s tax obligations are zero. For the same time period, it is shown by illustration 6 that
the business borrower receives the loan of 100€ and this cash inflow results to an attributable
tax of 10€ (10% * 100). So, the VAT paid for this period is 10€ as it results from both the bank’s
104
105
Poddar, English (1997), p.94
Poddar, English (1997), pp.94-95
27
and business’s cash flow calculations. However, additionally to the total tax the State desires to
earn a rate of return. So, the tax of 10€ is multiplied by the government rate and the amount of
1.1€ comes up. Consequently, the final tax which has to be paid off to the government for this
period is totally 11.1€.106
Period 1
Illustration 6 Business’s cash-flow system/ tax implications
Cash inflow (+)
Receiving loan = 100
Cash outflow (-)
Subtotal
100
Tax
Tax on loan=10
Credit
Subtotal
10
As it has already been estimated in example A, in period 2 the bank has to remit a tax of 0.90€
to the government. With reference to the borrower’s transactions, illustration 7 below points
up the business’s cash flows and the relevant tax consequences. More analytically, the business
repays the loan to the bank and this cash outflow of 100€ causes an input tax credit of 10€
(10% * 100). Furthermore, a second cash outflow occurs, that is to say the payment of loan
interest of 14€ to the bank which generates a tax credit of 1.4€ (10% * 14). An input tax credit
of 10.5€ is the tax result for this time period and derives from the spread between the
attributable tax of 0.90€ and the credit tax received of 11.4€.107
Period 2
Illustration 7 Business’s cash-flow system/ tax implications
Cash inflow (+)
Tax
Cash outflow (-)
Loan repayment= -100
Loan interest= -14
Subtotal
-100
-14
Credit
Credit tax on loan repayment = -10
Credit tax on loan interest= - 1.4
Subtotal
-10
-1.4
After the appropriate cash flow calculations for both time periods, the VAT which the
government earns in the end is 0.60€ and results from the spread between the tax paid to the
State of 11.1€ in the first period and the input tax credit received of 10.50€ in the second one.
The final VAT is equal to 10% tax on 6€ of the value added which is the consideration for the
106
107
Poddar, English (1997), pp.95-96
Poddar, English (1997), pp.95-96
28
supply of financial services to the depositor. So, in the end it is verified that the cash-flow
method functions properly because in this case a net tax had to be imposed only on the value
added of the service supplied to the depositor, as it happens in this occasion. 108
C. Resident consumer depositor- non-resident borrower
In this case, the financial institution provides services to a resident consumer depositor and a
non-resident borrower. With regard to period 1, illustration 8 shows that the bank has a cash
inflow of 100€ caused by the resident’s deposit and thus a VAT of 10€ has to be remitted to the
State. In the same time period the bank grants loan of 100€ to the non-resident borrower, but
this cash outflow doesn’t generate any tax liabilities. The cash-flow method doesn’t include to
its tax base the transactions with non-residents and therefore no VAT will be estimated for the
bank’s supply of financial services to the borrower. As a result for period 1, the total
attributable tax is 11.1€ which comes as a result from the tax of 10€ plus the government’s rate
of return amount 1.1€ (11% * 100).109
Period 1
Illustration 8 Bank’s cash-flow system/ tax implications
Cash inflow (+)
Deposit = 100
Tax
Tax on deposit= 10
Cash outflow (-)
Loan= -100
Subtotal
0
Credit
Credit tax on loan= 0
Subtotal
10
Regarding period 2, illustration 9 indicates that the non-resident borrower settles up the loan of
100€ plus a loan interest of 13.5€ (13.5% * 100), without any VAT implications to arise from
these two cash inflows for the bank. The loan interest in this situation is 13.5% and is reduced
in comparison with the general interest which is 14%, due to the bank’s aim to become more
attractive to non-residents in comparison with their domestic banks.110 On the other hand, the
depositor receives back from the bank the deposit of 100€ plus an interest of 5€. These cash
outflows cause an input tax credit of 10€ and 0.50€ respectively, which reflect the bank’s tax
consequences for period 2. As a result from both periods, the tax which has to be remitted to
the government is 0.60€, that is to say the spread between the tax paid to the State of 11.1€ in
108
109
110
Poddar, English (1997), p.96
Poddar, English (1997), p.97
Poddar, English (1997), p.97
29
the first period and the input tax credit received of 10.50€ in the second one, exactly like in
example B.111
Period 2
Illustration 9 Bank’s cash-flow system/ tax implications
Cash inflow (+)
Loan repayment = 100
Cash outflow (-)
Deposit withdrawal= -100
Subtotal
0
Loan interest= 13.5
Deposit interest= -5
8.5
Tax
Tax on loan repayment= 0
Tax on loan interest= 0
Credit
Credit tax on deposit withdrawal= -10
Credit tax on deposit interest= -0.5
Subtotal
-10
-0.5
4.5 Evaluation of the cash-flow method applied to credit services
4.5.1 Granting of credit
The credit is granted by a financial institution with the form of a loan where this is asked by
businesses or consumers who are in a difficult economical situation and they desire to facilitate
their current condition. With reference to the tax which has to be imposed on the value added
of this financial service, despite the complexities that it faces, the cash-flow method would
successfully apply for calculating accurately the relevant VAT.
As it has been analyzed through the description of the examples above112, the cash-flow
method could operate effectively for taxing the financial services of a capital nature which
include an exchange of funds, as it is the granting of credit with the form of a loan provision.
The exchange of funds is between the financial institution and the borrower and the
consideration for the provision of the loan is hidden in the profit margin. Nevertheless, the
cash-flow method lays some restrictions regarding the identity of the borrower and the lender.
For instance, the tax which has to be imposed on the value added of a loan supplied by a nonfinancial business to a customer who is consumer wouldn’t be able to be determined since the
cash-flow method excludes these transactions from its tax base. The cash-flow approach works
only in the cases of transactions between financial institutions with registered and nonregistered persons, that is to say businesses and consumers.
111
112
Poddar, English (1997), p.97
See section 4.4.1
30
More analytically, in the case where the borrower is a consumer which means not liable for VAT
and where also the depositor is a consumer, there is no need for two cash-flow systems to exist
for estimating the tax imposed on the value added for the service provided to them. Then,
where the borrower is a business and on the other hand the depositor is still a consumer, there
is a necessity for two cash-flow systems to operate because the borrower is now liable for VAT
and has to estimate separately the tax attributable and the credit tax. In the case where the
borrower is a non-resident and the depositor is a resident consumer, one cash-flow system has
to be implemented for both transactions since none of them is liable for VAT. The fact is that in
all these situations, the cash-flow method functions in an accurate and correct way. For
handling any problems which may arise, like for instance are the tax rate changes and the
difficulties that the small businesses borrowers face with the cash-flow calculations, the most
suitable to utilize are the cash-flow method with TCA and the truncated cash-flow method with
TCA. Consequently, for taxing the credit granting there is no need to canvass for another
method.
4.5.2 Negotiation and management of credit
The negotiation and management are two financial services which contribute to the accurate
function and effective completion of the credit granting procedure. The suppliers can either
charge remuneration for the services’ provision or not. In the case where no fee is charged, the
supply is out of the VAT scope. On the contrary, when the providers charge a consideration, the
reward’s nature has to be examined with the aim of canvassing how the services could be taxed
and if eventually the cash-flow method could work for them.
With reference to the credit negotiation, when a financial institution treats with the amount of
loan which the borrower would like to receive, the first and simplest case is where the
negotiation’s fee would be an explicit one. As a result, the negotiation’s entrance to the VAT
system would be straightforwardly completed by following the common procedure of taxation
and so there is no need to examine the implementation of the cash-flow method. The second
occasion is where the negotiation’s fee would be implicit and hidden in the profit margin.
Under these circumstances the negotiation could be effectively VAT taxed by the cash-flow
method. The negotiation could be characterized as the ancillary service of the credit granting
since it facilitates the loan process. Thus, it is understandable that in the absence of the
fundamental service which is the credit granting, we won’t had provided the negotiation to the
customers. Consequently, the cash-flow method would face granting and negotiation as a
single service and as a result the already mentioned process for taxing the credit granting will
be followed for estimating the respective VAT.
31
As regards the management, this service is usually supplied by the financial institution after the
granting of credit for checking that the process which has been agreed with the customers to
be followed is finished without any problems and delays to appear from the borrower’s
perspective. The VAT matter of this service is treated like the case of negotiation, that is to say
the two different natures of the remuneration have to be described so as to find the proper
method of taxation for each of them. The initial case is where the management’s reward would
be a definite one. In this occasion, there would be no necessity to put into practice the cashflow method for calculating the tax because the management could be very easily taxed under
the normal VAT system like the rest services. The next case would be if the management is a
service of capital nature and its fee is hidden in the profit margin. Likewise the occasion of
negotiation, the cash-flow method would successfully operate for correctly estimating and
imposing the VAT. The credit management could not be characterized as the main service but
as an auxiliary to the granting of credit process which means that it wouldn’t had been supplied
as a discrete service to businesses and consumers. As a result, for estimating the respective tax,
granting and management could be handled by the cash-flow method as one sole service and
not as two separate.
5. Conclusion
Within the EU economy, the financial services are frequently provided by any economic or noneconomic enterprise to its customers. As regards their tax condition, most of them are VAT
exempt according to Article 135(1) RVD. This VAT exempt status is mostly provoked due to the
interpretation lack of what can be defined as the relevant remuneration which is charged by
the provider of the economical service. However, this complexity relates only to the margin
based products and not to the financial services where their reward is explicit, as for instance
are the consultancy services or the safe-deposit box rental charges which are normally taxed
under the credit invoice VAT system. The intense concern for the more than a few negative
consequences which arise from the VAT exempt condition of these services, with the nonrecoverable tax to be referred as one of the most important, is reflected also by the
Commission’s various proposals for reforming the current VAT treatment of the financial
services by focusing mostly on their re-definition and the right of opting the taxation.
The granting, negotiation and management of credit are core economic services where each of
them plays an important role to the commercial transactions between the firms and their
customers. Their basic aim is to facilitate and normalize the customers’ tricky economical
situations. According to the provision (b) of Article 135(1) RVD, these services are VAT exempt
and from this status some negative consequences are generated for the businesses operation,
as for example is the distortion of competition. As it has already been analyzed through the
32
relevant case-law, it is very easy for quite a lot of misunderstandings to arise, as for instance is
what an economical exempt service is and how it has or not to be treated regarding taxation. As
a result, for the correct VAT treatment of these services it is absolutely necessary to be more
specific to their definition and to find the most suitable method for entering them to the
normal VAT system.
The cash-flow method constitutes an influential suggestion for taxing the exempt financial
services which are only of capital nature and their remuneration is implicit and hidden in the
profit margin. As a method has significant advantages, but also holds some disadvantages
which have kept it until now out of practice. However, the truncated cash-flow method with
TCA and the cash-flow method with TCA have tried to solve some of its difficulties. In particular,
the cash-flow method could properly calculate and impose the relevant tax on the credit
granting’s value added. Concerning, the negotiation and management of credit if the
remuneration charged by the provider would be an explicit one, then these services could be
normally taxed under the credit invoice system and there is no need to examine if the cash-flow
method could work for them. Alternatively, if the negotiation’s and management’s reward
would be implicit and hidden in the profit margin, the cash-flow method could effectively
estimate the VAT. The method in order to calculate the tax, it would face these services and
granting of credit as one sole service and not as two or three different since the negotiation and
management are recognized as ancillary services to the provision of credit.
The necessity of taxing the exempt financial services in general and more specifically the
granting, negotiation and management of credit is more forceful than ever. The total gain
which could be derived from the full taxation of the financial services would be significant for
both the EU governments and for the businesses. All the current negative consequences like
the distortion of competition will be disappeared and the enterprises’ function will be
improved. So, more research has to be done from both a legal and economical perspective
within the EU in order to get over the obstacles which exist for effectively taxing the financial
services and eventually solving this major problem of the VAT exemption.
33
List of references
Sources of law
1. Commission of the European Communities Brussels, 28.11.2007 SEC(2007) 1555,
Commission Staff Working document accompanying the Proposal for a council Directive
amending Directive 2006/112/EC on the common system of value added tax, as regards
the treatment of insurance and financial services
2. Commission of the European Communities Brussels, 28.11.2007 COM(2007) 746 Final,
Proposal for a Council Regulation laying down implementing measures for Directive
2006/112/EC on the common system of value added tax, as regards the treatment of
insurance and financial services
3. Commission of the European Communities Brussels, 28.11.2007 COM(2007) 747 Final,
2007/0267 (CNS), Proposal for a Council Directive amending Directive 2006/112/EC on
the common system of value added tax, as regards the treatment of insurance and
financial services
4. Council of the European Union Brussels, 30.09.2011 Proposal for a Council Directive
amending Directive 2006/112/EC on the common system of value added tax, as regards
the treatment of insurance and financial services
5. Directive 2000/35/EC of the European Parliament and of the Council of 29 June 2000 on
combating late payment in commercial transactions
6. European Commission, Consultation Paper on modernizing Value Added Tax obligations
for financial services and insurances
7. Recast VAT Directive 2006/112/EC of 28 November 2006 on the common system of
value added tax
Books, Articles, Other Material
1. Andersson, P. 2001, Expertise in Credit Granting: Studies on Judgment and DecisionMaking Behavior, Stockholm School of Economics
2. Comments by the European Association of Co-operative Banks (EACB), the European
Association of Public Banks (EAPB), the European Banking Federation (EBF), the
European Fund and Asset Management Association (EFAMA), Insurance Europe
(formerly the CEA) and the European Federation of Insurance Intermediaries (BIPAR) on
34
the EC’s proposal to reform the VAT rules applied to financial and insurance services,
EBF Ref. N° 0120, Brussels, May 2012
3. De la Feria, R. & Krever, R., Ending VAT Exemptions: Towards A Post-Modern VAT,
Oxford University Centre for Business Taxation, Working Paper 12/28
4. De la Feria, R. & Lockwood, B. 2009, Opting for Opting In? An Evaluation of the
Commission’s Proposals for Reforming VAT for Financial Services
5. Ernst & Young, Value Added Tax: A study of Methods of Taxing Financial and Insurance
Services, 1996
6. FECMA Magazine for European Credit Managers, Credit Management goes straight up,
1/2012
7. Henkow, O. 2007, Financial Activities in European VAT: A Theoretical and Legal Research
of the European VAT System and the Actual and Preferred Treatment of Financial
Activities, Lund University
8. International Monetary Fund, Tax Policy Handbook, 1995
9. KPMG & Leaseurope publication, European Leasing, 2007
10. The Institute for Fiscal Studies 1978, The Structure and Reform of Direct Taxation,
Report of a Committee chaired by Professor J.E. Meade
11. Opinion Statement on Proposals by CFE for a VAT Directive and Regulations regarding
Financial Services, (TAXUD/2144/07 Rev. 1 – EN Brussels, 16 July 2007 and
TAXUD/2146/07 – EN Brussels, 13 July 2007)
12. Poddar, S. 2003, Consumption Taxes: The Role of the Value-Added Tax, in Taxation of
Financial Intermediation: Theory and Practice for Emerging Economies, Honohan P.
13. Poddar, S. & English, M. 1997, Taxation of Financial Services under a Value-Added Tax:
Applying the Cash Flow Approach, National Tax Journal, pp.89-112
14. PwC, Study to Increase the Understanding of the Economic Effects of the VAT Exemption
for Financial and Insurance Services, November 2006
15. PwC, Study How the EU VAT exemptions impact the Banking Sector, October 2011
16. PwC, VAT Bulletin Financial Services, November 2007
35
17. VAT Survey, Financial Services, Survey on the recovery of input VAT in the financial
sector, 2006, IBFD
18. Terra, B. 2010, VAT and Financial Services: The Proposals for Change, University of Lund,
Vol.9
19. Terra, B. & Kajus, J. 2011, A Guide to the European VAT Directives, Introduction to
European VAT, Vol.1
Case-Law
1. Opinion of Advocate General Sir Gordon Slynn delivered on 18 November 1981 in Case
C-8/81, Ursula Becker v. Finanzamt Munster-Innenstadt, ECR [1982] P. 00053
2. Case C-8/81, Ursula Becker v. Finanzamt Munster-Innenstadt, ECR [1982] P. 00053
3. Case C-222/81, B.A.Z Bausystem AG v Finanzamt München für Körperschaften, ECR
[1982] P. I-02527
4. Case C-348/87, Stiching Uitvoering Financiële Acties v. Staatssecretaris van Financiën,
ECR [1989] P. 01737
5. Opinion of Mr. Advocate General Jacobs delivered on 3 March 1993 in Case C-281/91,
Muys' en De Winter's Bouw- en Aannemingsbedrijf BV v Staatssecretaris van Financiën,
ECR [1993] P. I-05405
6. Case C-281/91, Muys' en De Winter's Bouw- en Aannemingsbedrijf BV v Staatssecretaris
van Financiën, ECR [1993] P. I-05405
7. Case C-306/94, Régie Dauphinoise- Cabinet A. Forest SARL v. Ministre du Budget, ECR
[1996], P. I-03695
8. Case C-2/95, Sparekassernes Datacenter (SDC) v. Skatteministeriet, ECR [1997] P. I03017
9. Case C-142/99, Floridienne SA, Berginvest SA v. Belgian State, ECR [2000] P. I-09567
10. Case C-235/00, Commissioners of Customs & Excise v. CSC Financial Services Ltd, ECR
[2001] P. I-10237
11. Case C-185/01, Auto Lease Holland BV v. Bundesamt für Finanzen, ECR [2003] P. I-01317
36
12. Opinion of Advocate General Léger delivered on 12 September 2002 in Case C-77/01,
Empresa de Desenvolvimento Mineiro SGPSSA (EDM) v. Fazenda Pública, ECR [2004] P. I04295
13. Case C-77/01, Empresa de Desenvolvimento Mineiro SGPSSA (EDM) v. Fazenda Pública,
ECR [2004] P. I-04295
14. Case C-472/03, Staatssecretaris van Financiën v. Arthur Andersen & Co. Accountants c.s.,
ECR [2005] P. I-01719
15. Case C-453/05, Volker Ludwig v Finanzamt Luckenwalde, ECR [2007] P. I-05083
16. Case C-98/07, Nordania Finans A/S, BG Factoring A/S v Skatteministeriet, ECR [2008] P. I01281
17. Case C-259/11, DTZ Zadelhoff vof v. Staatssecretaris van Financiën
18. Opinion of Advocate General Sharpston delivered on 8 May 2012 in Case C-44/11,
Finanzamt Frankfurt am Main V-Höchst v Deutsche Bank AG
19. Case C-44/11, Finanzamt Frankfurt am Main V-Höchst v Deutsche Bank AG
20. Case C-653/11, Her Majesty’s Commissioners of Revenue and Customs v. Paul Newey
37