19238
VALUE ADDED TAX — input tax — partially exempt trader — agreed special method for attribution of residual input tax — credit card bank — securitisation of credit card receivables — assignment of receivables to Jersey trustee — trustee holding assigned receivables on trust for Jersey company which issued loan notes on security of receivables — whether assignment capable of amounting to supply by bank or merely security for loan — when receivables paid by customers, moneys returned to credit card bank and collected receivables replaced by new receivables — whether replacements amount to supply — if supply, whether made for consideration — measure of consideration — whether any supply made by bank “incidental” — whether trustee truly belonging outside Member States — whether special method denominator correctly compiled — Sixth VAT Directive, arts 9, 11, 13, 17, 19 — VAT Act 1994, ss 4, 9 26, Sch 5, Sch 9 Group 5, Item 1 — VAT Regulations 1995, regs 101, 102, 103 — VAT (Input Tax) (Specified Supplies) Order 1999, arts 2, 3 — VAT (Place of Supply of Services) Order 1992, art 16
MANCHESTER TRIBUNAL CENTRE
CAPITAL ONE BANK (EUROPE) plc
Appellant
- and -
THE COMMISSIONERS FOR HER MAJESTY’S REVENUE AND CUSTOMS
Respondents
Tribunal:Colin Bishopp (Chairman)
Kenneth Goddard MBE
Sitting in public in London on 12, 13, 16, 17, 18, 19 and 20 May 2005
Roderick Cordara QC and Mark Smith, instructed by PricewaterhouseCoopers, for the Appellant
Nicholas Paines QC and Peter Mantle, instructed by the Acting Solicitor for HM Revenue and Customs, for the Respondents
© CROWN COPYRIGHT 2005
1
DECISION
Introduction
1.The parties to this appeal identified six discrete issues for our determination but for the purposes of an introductory summary we can reduce them to three. First, does the assignment by a credit card bank to a company incorporated in Jersey, in the course of a process known as securitisation, of present and future debts owed and to become owed to that bank by its customers (“receivables”) have the objective characteristics of a supply, as that term is understood for the purposes of VAT? Put another way, is it, as the Appellant contends, a true sale made in the course of its ordinary business activities, or is the proper view, as the Respondents assert, that the Appellant borrowed against the security of the debts? Second, if the assignment does amount to a supply, is it incidental to the Appellant’s business activities with the consequence that it is to be excluded from its partial exemption calculations, for which it has an agreed special method? Third, if such an assignment does amount to a supply, and is not incidental, how is the value of the consideration received for it to be determined and brought into the calculation?
2.In form, this is an appeal by Capital One Bank (Europe) plc (“COBE”) against the Respondents’ rejection of its claim for a refund of input tax amounting to £11,147,728.72, made in its return for the period ended 30 June 2002. COBE is a partially exempt trader (and the representative member of a VAT group whose members make both taxable and exempt supplies) and the return included the annual adjustment its agreed special method required it to make for its “longer period” from 1 April 2001 to 31 March 2002. In making the adjustment, COBE brought into the calculation what it maintains was the consideration for the assignment. It says, for reasons to which we will come, that this amount is to be attributed to taxable supplies for the purposes of the adjustment. The claim was refused, with reasons, in a letter dated 1 April 2003, and it is that letter which contains the decision on which we are required to adjudicate. The reasons given in the letter were substantially the same as those advanced before us and there is therefore no need to set them out here. We are not asked to deal with the arithmetic of the claim, or even its detail, but only to determine some matters of principle.
3.The Appellant was represented by Roderick Cordara QC, leading Mark Smith, and the Respondents by Nicholas Paines QC, leading Peter Mantle. We heard the oral evidence of Kevin Ingram, a partner in Clifford Chance, who was responsible for the contracts by which the assignment with which we are concerned was effected; of Richard Gerwat, a Jersey advocate whose firm, and a trust company of which he is a director, were involved in the securitisation transactions; and of David Bonsall who has had considerable experience of securitisation, initially as a practising solicitor and latterly as a merchant banker. Mr Ingram gave evidence primarily of fact, but we accept him in part as an expert; it was acknowledged by the Respondents that he is a leading practitioner in the field. Mr Bonsall was offered as an expert witness, and we accept him as such, though it was agreed that some parts of his evidence should be excluded as they strayed into areas about which he could not properly express an expert opinion. We had statements or reports from all three of those witnesses, on which they expanded orally. In addition we had unchallenged statements made by Corey Sesin, Adam Mussert and Stephen Hulme, all employees of COBE’s trading group. If we refer hereafter to Mr Ingram rather more than to Mr Bonsall, we do so because Mr Ingram, as the author of the agreements, was better able to speak about their detail, but we have not disregarded Mr Bonsall’s evidence; and in most respects he and Mr Ingram were in agreement. We were provided also with a substantial volume of documents, including the lengthy contracts by which the securitisation was effected.
4.There was no significant disagreement between the parties about the principal facts, with which we will deal first, in the next section of this decision. We draw them in part from what we were told was common ground, and in part from the witnesses and the documentation. In the interests of brevity, we mention the evidence only when it is necessary to do so, for example in order to deal with those few matters which were not agreed, or for clarity. In dealing with the facts we have concentrated on those which are necessary for our decision and have omitted those which are not necessary either for that purpose or as background information. We deal at paragraph 26 with the detail of the contracts by which the securitisation was effected, and at paragraph 63 we summarise our findings of fact; at paragraph 67 we describe the agreed special method and its application; at paragraph 82 we come to the six individual issues which Mr Paines identified in the Respondents’ skeleton argument and which, after some slight initial hesitation, Mr Cordara accepted as a fair description of the questions we must decide, followed by an examination and discussion of the parties’ arguments; and at paragraph 163 we set out a summary of our conclusions.
The facts
5.Until 31 August 2000 the United Kingdom branch of Capital One Bank (“COBUS”), a United States corporation, carried on business in the United Kingdom. COBE, which is incorporated in the United Kingdom and is a wholly-owned subsidiary of COBUS (which is in turn a wholly-owned subsidiary of Capital One Finance Corporation, also a United States corporation), took over COBUS’s business in the United Kingdom as a going concern, without making any significant changes to it, from 1 September 2000. COBUS had until then been the representative member of a UK VAT group and, when it took over the business, COBE also succeeded to COBUS’s position as the representative member of the VAT group. COBUS then ceased to trade within the United Kingdom. COBUS itself made (and COBE now makes) no taxable supplies (although COBE makes some “out of scope with recovery” supplies) since their core business was and is the making of exempt supplies falling within Group 5 of Schedule 9 to the Value Added Tax Act 1994, but other companies within the VAT group did and do make some taxable supplies.
6.COBUS and COBE, despite their names, are not banks in the conventional sense, providing the full range of services expected of a high street bank, but operate credit card businesses, providing credit cards to members of the public and servicing their customers’ accounts. They also accept deposits.
7.COBUS and, latterly, COBE incurred and COBE continues to incur input tax on their overheads, such as the costs of acquiring and maintaining information technology systems, of running a call centre and on the general expenses of servicing and administering the credit card accounts. Like any trader, or VAT group, making some taxable and some exempt supplies, COBUS and, now, COBE were and are entitled to recover part of that input tax. In late 1997 COBUS, at that time the representative member of the VAT group, agreed with the Respondents—then the Commissioners of Customs and Excise—that it could use a special method, within the meaning of regulation 102(1) of the Value Added Tax Regulations 1995 (SI 1995/2518), for its partial exemption calculation. We set out the terms of the agreed special method in the section beginning at paragraph 67 below.
COBE’s business
8.COBE is licensed to provide credit and is regulated, within the UK, by the Financial Services Authority. Its business is run in much the same way as any other credit card business: its customers are issued with cards which entitle them to make purchases, and obtain cash advances, up to an agreed aggregate maximum amount. COBE is required to finance its customers’ purchases by paying to the retailers and other suppliers, through the banking system, the cost of the goods or services acquired by the customer, less a charge—a variable percentage of the price—known as “interchange”, and to make cash available, also through the banking system, to satisfy its customers’ demands for advances. Monthly, customers who have any sum outstanding must pay to COBE an amount between a specified minimum and the total then outstanding. Those who do not pay the full amount are charged interest and COBE also levies some fees and penalties, for example for late payment by customers of the minimum amount. The interest, fees and penalties (that is, all of COBE’s receipts from its customers, other than of capital) are together known as “finance charges”.
9.Three characteristics of the credit card business are of relevance in this appeal. The first is the considerable amount of capital which is necessary. The second is the customer’s right to make purchases, or obtain cash advances, without notice provided he remains within his agreed credit limit. The third is the fact that, in consequence, the amount of capital which is at any time outstanding (and, correspondingly, the overall sum owed to COBE by its customers) is variable. Although, as we shall mention later, some predictions can be made with reasonable accuracy and certainty about the behaviour of a large group of people such as the customers of a credit card bank, there are seasonal variations—particularly at Christmas—in the amounts those customers spend, and general economic conditions, wholly outside the issuer’s control, may encourage or discourage spending, or increase or diminish the amounts which customers as a group pay in discharge of their outstanding balances each month.
10.A credit card company, like any other lending institution, earns its profits from the difference—the “spread”—between the amount it can earn, in the form of the interest and other charges due to it from its customers, and the cost to it of obtaining the funds used to pay for the customers’ purchases and cash advances—its working capital. Although there are, we understand, quite wide differences between the amounts credit card companies charge their customers, tempered by special offers and discounts, there is nevertheless intense competition and, in consequence, continual downward pressure on the amounts which can be charged, particularly by way of interest. It is correspondingly in the companies’ interests to minimise the cost to them of the funds they use. Credit card companies must, not least for regulatory reasons, have some capital of their own but they are not required to fund the entirety of their operations from their own resources. They may instead (and, in practice, almost all do) borrow some of their working capital.
11.While issuers which carry on other types of business in addition may draw on several sources for their capital—for example the UK clearing banks may use the sums kept by customers in their current accounts on which little, if any, interest is paid—“monoline” issuers (that is, those which have little or no other business activity) such as COBE do not have access to relatively cheap and plentiful funds. COBE has been able to accept retail deposits since September 2000, when it obtained regulatory approval to do so, but, because it is not a conventional high street bank, must always offer a significant interest rate in order to attract funds. Such companies may—as COBE has done—borrow from their parent companies, or they may borrow on the capital markets. The former course has two disadvantages: the parent may not have sufficient funds of its own and, even if it has, the regulatory authorities in both the UK and the US impose limits on the amounts which may be lent and borrowed in this way. COBE’s borrowing from COBUS is restricted by the Federal Reserve to $550 million, too little to satisfy its needs. A simple borrowing on the capital markets is comparatively expensive for an institution such as COBUS, which has a much lower credit rating than a UK clearing bank, while COBE has no credit rating at all of its own and, if it were to borrow, would have to procure COBUS’s guarantee of the loan. Even then, the Financial Services Authority (“FSA”), COBE’s UK regulator, will not permit it to be over-reliant on its parent.
12.The credit rating of a financial institution, and of securities issued by such institutions and others (for example quoted companies) is determined by credit rating agencies, of which the best known are Standard and Poor’s, Fitch and Moody’s. The best possible rating (using Standard and Poor’s system) is AAA, signifying that the risk of default is no greater than that on US government bonds. On the same scale, the lowest commercially recognised rating is BBB which, in the period with which we are concerned, was COBUS’s rating. Unsurprisingly, the higher an institution’s credit rating, the lower the interest rate it must expect to pay on borrowed funds; but an institution cannot (except over a comparatively long time) acquire a higher credit rating because of its track record, and even then there will be material, external, factors which it cannot control itself. In addition, COBE’s credit rating, if it had one, would be adversely affected by its being a monoline business with no opportunity to offset losses from one activity against profits derived from another.
Securitisation
13.A possible solution, from the point of view of an issuer such as COBE, and the focus of this appeal, is securitisation, a capital-raising process which was invented, we understood, in the United States, and was originally used in the residential mortgage market but has since been adopted by other capital-intensive businesses generating a predictable income stream. We were told that it has been commonly and very extensively used in the UK and in continental Europe for between ten and fifteen years, and those availing themselves of the process now include clearing banks (despite their ready access to cheap funds) and other large financial institutions.
14.A credit card issuer, or any other institution wishing to do so (an “originator”), obtains capital by assigning the sums it is due to receive from its customers (“Receivables”) to another legal entity which, directly or indirectly, borrows in the capital markets, using the assigned receivables as security, and paying the amount it borrows to the credit card company. The lender assumes the risk that the issuer’s customers will fail to pay their debts, but it can measure the risk of that failure against the known historical experience and the substantially predictable behaviour of a large group of people. The risk is assessed by the rating agencies, which give the assigned receivables (or, perhaps more accurately, the negotiable instruments for which they constitute the security) an appropriate rating. In practice, we were told, the risk of default, beyond an assumed level of which account is taken when receivables are securitised, is very small and, typically, a portfolio of credit card receivables securitised in the manner in issue in this appeal will attract a credit rating of AA (again adopting Standard and Poor’s rating system), equivalent to that of a UK clearing bank; potentially, credit card receivables, if subject to “term” securitisation (that is, securitisation for a fixed term), can achieve the highest possible rating, of AAA. Mr Ingram explained that achieving the highest practicable rating is the most important objective of a securitisation, to which all the others are subordinate. Large parts of the contracts, to which we shall come shortly, are devoted to ensuring that nothing is done which might adversely affect the rating agencies’ assessment of the securitised assets. The advantage to the issuer is that, because of the higher rating, the cost to it of obtaining the funds it needs to conduct its business (that is, the interest it must pay) is lower than it would be if it were to borrow directly from the lender (commonly referred to, in the context of securitisations, as the “investor”).