Flashback on ECJ Cases C-93/10 (GFKL Financial Services) – Purchases of defaulted debts at a price below their face value is not a taxable transaction/economic activity

On Octover 27, 2011, the ECJ issued its decision in the case C-93/10 (GFKL Financial Services).

Context: Sixth VAT Directive – Articles 2(1) and 4 – Scope – Concepts of ‘supply of services effected for consideration’ and ‘economic activity’ – Sale of defaulted debts – Sale price lower than the face value of those debts – Assumption of responsibility by the purchaser for the recovery of those debts and for the risk of defaulting debtors

Article in the EU VAT Directive

Articles 2(1) and 4 of Sixth Council Directive 77/388/EEC

Article 2(1) of the Sixth Directive provides:

‘The following shall be subject to [VAT]:

1. the supply of goods or services effected for consideration within the territory of the country by a taxable person acting as such’.

Article 4(1) and (2) of that directive is worded as follows:

‘1. “Taxable person” shall mean any person who independently carries out in any place any economic activity specified in paragraph 2, whatever the purpose or results of that activity.

2. The economic activities referred to in paragraph 1 shall comprise all activities of producers, traders and persons supplying services including mining and agricultural activities and activities of the professions. The exploitation of tangible or intangible property for the purpose of obtaining income therefrom on a continuing basis shall also be considered an economic activity.’

Facts

GFKL is the sole and controlling member of a company incorporated under German law which on 26 October 2004 purchased from a bank mortgages on immovable property and debts relating to 70 loan agreements that had been terminated and declared mature.
On the reference date, 29 April 2004, the face value of those debts was EUR 15 500 915.16.
The purchase agreement stipulated, inter alia, that, from the reference date, those mortgage rights and debts were deemed managed or held for and at the risk of the purchaser, that the purchaser was entitled to the payments attributable to the mortgage rights and debts and that liability of the seller for the recovery of the debts in question was excluded.
However, following a letter from the Federal Finance Ministry of 3 June 2004 concerning the implementation of the Court’s judgment in Case C‑305/01 MKG-Kraftfahrzeuge-Factoring [2003] ECR I‑6729, the parties to the debt purchase agreement considered that, in the light of considerable payment defaults, the realisable portion of the debts in issue was much lower than their face value and set the economic value of those debts at EUR 8 956 101.
Furthermore, taking the view that recovery of those debts was to be spread out over a period of about three years, the parties, on the basis of an agreed interest rate set at 5.97%, reached agreement as to the grant by the purchaser to the seller of credit entailing interest of EUR 556 293, so that, after the deduction of that interest, the economic value of the debts was EUR 8 399 808.
The definitive purchase price for the debts in issue was finally fixed at EUR 8 034 883 and the purchase agreement did not provide for the possibility of adjusting this price at a later time.
Furthermore, the parties were of the view that, by purchasing those debts, the purchaser did not supply a service to the seller which was liable to tax. However, they stipulated that, in the event that the tax authorities did not agree with that analysis, the difference of EUR 364 925 between the economic value reduced by the interest and the definitive purchase price of the debts should be regarded as the consideration for that service.
Having submitted a provisional turnover tax return in which it stated that that difference constituted the payment for a taxable service provided to the seller of the debts in issue, GFKL lodged an objection to its provisional tax return, which the Finanzamt dismissed as unfounded.
GFKL then brought an action before the Finanzgericht, which upheld the action, holding that, unlike true factoring, the transfer of defaulted debts does not result in the supply to the seller of those debts of a service liable to turnover tax.

Questions

For the interpretation of Article 2(1) and Article 4 of the Sixth Council Directive of 17 May 1977 on the harmonisation of the laws of the Member States relating to turnover taxes (77/388/EEC):

Does the sale (purchase) of defaulted debts constitute, on account of the assumption of responsibility for debt recovery and the risk of loss, a service for consideration and an economic activity on the part of the purchaser of the debts even if the purchase price

─ is not based on the face value of the debts, with a flat-rate reduction agreed for the assumption of responsibility for debt recovery and the risk of loss, but

─ is set by reference to the risk of loss estimated for the debt concerned, with only secondary importance attached to the recovery of the debt compared to the reduction for the risk of loss?

If the answer to Question 1 is in the affirmative, for the interpretation of Article 13B(d)(2) and (3) of the Sixth Council Directive of 17 May 1977 on the harmonisation of the laws of the Member States relating to turnover taxes (77/388/EEC):

(a) Is the assumption of the risk of loss by the purchaser of defaulted debts at a purchase price significantly lower than their face value exempt from tax, as being the provision of a different security or guarantee?

(b) If the assumption of the risk is exempt from tax, is the recovery of the debts exempt from tax, as part of a single service or as an ancillary service, or taxable as a separate service?

If the answer to Question 1 is in the affirmative and no exempt service has been supplied, for the interpretation of Article 11A(a) of the Sixth Council Directive of 17 May 1977 on the harmonisation of the laws of the Member States relating to turnover taxes (77/388/EEC):

Is the consideration for the taxable service determined by the recovery costs presumed by the parties or by the actual recovery costs?

AG Opinion

(1) The purchase of a portfolio of defaulted debts constitutes a service and an economic activity on the part of the purchaser of the debts within the meaning of Articles 2(1) and 4 of Sixth Council Directive 77/388/EEC of 17 May 1977 on the harmonisation of the laws of the Member States relating to turnover taxes – Common system of value added tax: uniform basis of assessment.

However, since there is no direct link in the present case between the service provided and the consideration received, the supply of such a service does not fall within the scope of application of the Sixth VAT Directive.

There is no need to answer to the second and third questions. However, in the alternative I propose the following:

(2) The present situation amounts to ‘debt collection’ within the meaning of Article 13B(d)(3) of the Sixth VAT Directive, and is therefore not exempt from VAT.

(3) The consideration in the present case should be based on the difference between the amount of debt that is actually recovered by GFKL, and the price paid by it in acquiring the debt from the Bank.

Decision

Articles 2(1) and 4 of Sixth Council Directive 77/388/EEC of 17 May 1977 on the harmonisation of the laws of the Member States relating to turnover taxes – Common system of value added tax: uniform basis of assessment must be interpreted as meaning that an operator who, at his own risk, purchases defaulted debts at a price below their face value does not effect a supply of services for consideration within the meaning of Article 2(1) and does not carry out an economic activity falling within the scope of that directive when the difference between the face value of those debts and their purchase price reflects the actual economic value of the debts at the time of their assignment.

Summary

Sale of unpaid receivables – Sale price less than the nominal value of those receivables

An economic operator who purchases outstanding debts at his own risk for a price below their face value is not providing a service for consideration or an economic activity falling within the scope of the Directive where the difference between the face value of those claims and their purchase price is the actual reflects the economic value of the receivables at the time of transfer.

Source