VAT Exemption Whether Services of Appellant Company Those of Negotiation and Payment Of

19854

VAT – exemption – whether services of appellant company those of negotiation and payment of solicitors carrying out remortgaging transactions for mortgage lenders and exempt as within items 1 and/or 5 of Group 5 of Schedule 9 to VATA 1994 – or standard rated supplies of management, auditing and provision of IT services – appeal dismissed

MANCHESTER TRIBUNAL CENTRE

MORPHEUS 2002 LIMITEDAppellant

- and -

THE COMMISSIONERS FOR

HER MAJESTY’S REVENUE AND CUSTOMSRespondents

Tribunal:David Demack (Chairman)

Sitting in public in Manchester on 21 and 22 July 2004 and 25 and 26 April 2006

On 21 and 22 July 2004:

Roderick Cordara QC instructed by Messrs Pricewaterhouse Coopers, chartered accountants, London, for the Appellant

Mario Angiolini of counsel instructed by the Acting Solicitor for HMRC Revenue and Customs for the Respondents

On 25 and 26 April 2006:

Roderick Cordara QC and Edmund King instructed by Messrs Pricewaterhouse Coopers chartered accountants London for the Appellant.

Rupert Anderson QC and Mario Angiolini instructed by the Acting Solicitor for HM Revenue and Customs for the Respondents

© CROWN COPYRIGHT 2006

DECISION

Introduction

1. In a letter of 24 June 2002 to what are now Her Majesty’s Commissioners for Revenue & Customs (“HMRC”), KPMG, who were then advisers to Legal Marketing Services Limited (“LMS”), the company whose supplies are at issue in this appeal, explained the nature of its business and its liability to VAT as follows:

“LMS is a fully taxable business involved in managing the provision of legal work on re-mortgages for major lenders such as Lender A, Lender B and various building societies. LMS receives instructions on a new re-mortgage case from these parties. LMS then chooses, from a national panel, which law firm it will assign the case to.”

1. As only solicitors and licensed conveyancers are allowed to prepare the instruments necessary to transfer or charge any property in the remortgage process, the mortgage lenders must instruct independent solicitors if their own in house solicitors do not prepare their mortgage deeds. It would be an offence, and thus illegal, for LMS to prepare such documents – see section 22 of the Solicitors Act 1974, and section 36 of the Courts and Legal Services Act 1990.
2. LMS was taken over by the appellant company, Morpheus 2002 Limited (“Morpheus”), in 2003, and became part of the Morpheus group of companies. As part of the takeover process, LMS changed its advisers to PricewaterhouseCoopers (“PwC”). On 18 July 2003 they wrote to HMRC asking them to reconsider LMS’s liability to VAT on its supplies. On 6 August 2003, HMRC confirmed by letter from one of their officers that the supplies, which remained the same as those made in 2002, were standard rated, saying:

“Having examined all the documents and considered your representations I am of the opinion that the negotiation services provided by your client relate to legal services, in particular bulk conveyancing.

As the principal supply refers to a taxable service, it follows therefore that your client’s entire supply is standard rated for VAT purposes”.

1. PwC asked for the decision to be reviewed. By letter of 22 September 2003, HMRC confirmed their original decision. Morpheus appeals against the decision on review, giving the following reasons for appealing:

“1. The respondents have erred in law and in fact in deciding that the negotiation and payment services provided by the appellant are taxable supplies for VAT purposes.

2. The payment and negotiation services provided by the appellant should, in law and in fact, be treated as exempt services for VAT purposes.

3. The ancillary services provided by the appellant are incidental to the payment and negotiation services provided by the appellant and, therefore, are also exempt from VAT”.

1. Morpheus maintains that LMS’s services consist of:

(a) negotiation services, i.e. negotiating for the mortgage lenders to which it is contracted the fees of its panel solicitors for the conveyancing work involved in the re-mortgaging process;

(b) fee payment management, i.e. centrally collecting from the mortgage lenders its own and the solicitors’ fees for the work carried out for them, and accounting to the individual firms of solicitors for their fees;

(c) panel management services, i.e. allocating to and subsequently monitoring cases dealt with by the solicitors; and

(d) quality assurance services, i.e. ensuring that panel solicitors are efficient and competent

6.Morpheus claims that items (a) and (b) constitute the dominant supply and are exempt supplies of financial services made pursuant to items 1 and / or 5 of Group 5 of Schedule 9 to the Value Added Tax Act 1994 (“VATA 1994”), and / or pursuant to Article 13B(d)(3) of the EC Sixth VAT Directive (77/388/EEC) (“the Sixth Directive”). Additionally, it claims that items (c) and (d) are ancillary to those of (a) and (b), and thus also qualify for exemption. Alternatively, Morpheus claims that items (c) and (d) constitute separate standard rated supplies.

7.HMRC’s case, as summarised in the statement of case, is that:

1. The nature of the service provided by LMS is such that it would be artificial to regard it as other than a single composite supply or to regard any individual activity as being ancillary to another.

1. LMS is not required to and does not provide any negotiation service to its customers. The negotiations which it undertakes are undertaken in its own right and would not, in any event, fall within any of the exemptions listed in Group 5 to Schedule 9 of VATA.

1. To the extent that the service provided by LMS may be treated as other than a single composite supply (and it is not accepted that it may), the supply of payment services, which is accepted as being capable of falling within the exemption under item 1 of the said Group 5, is ancillary to the principal supply of arranging for and managing the provision of legal services.

1. The service provided by LMS is a single supply for VAT purposes and taxable at the standard rate.

The Legislative Framework

8.As mentioned above, the domestic law upon which Morpheus makes its claims is to be found in Schedule 9 to VATA 1994. Items 1 and 5 of Group 5 of that Schedule and the associated Notes are in the following terms:

“1. The issue, transfer or receipt of, or any dealing with, money, any security for money or any note or order for the payment of money.

[…]

5. The provision of intermediary services in relation to any transaction comprised in item 1, 2, 3, 4 or 6 (whether or not any such transaction is finally concluded) by a person acting in an intermediary capacity.

NOTES

(5). For the purposes of item 5 “intermediary services” consist of bringing together, with a view to the provision of financial services

(a) persons who are or may be seeking to receive financial services, and

(b) persons who provide financial services together with (in the case of financial services falling within item 1, 2, 3 or 4) the performance of work preparatory to the conclusion of contracts for the provision of those financial services, but do not include the supply of any market research, product design, advertising, promotional or similar services or the collection, collation and provision of information in connection with such activities.

(5A)For the purposes of item 5 a person is ‘acting in an intermediary capacity’ whenever he is acting as an intermediary, or one of the intermediaries, between

(a) a person who provides financial services and

(b) a person who is or may be seeking to receive financial services

(5B) For the purposes of notes 5 and 5A ‘financial services’ means the carrying out of any transaction falling within item 1, 2, 3, 4 or 6.

9.Items 1 and 5 of Schedule 9 represent the United Kingdom’s transposition of Article 13B(d)3 of the Sixth Directive into domestic law. That article provides as follows:

“Without prejudice to other Community provisions, Member States shall exempt the following under conditions which they shall lay down for the purpose of ensuring the correct and straightforward application of the exemptions and of preventing any possible evasion, avoidance or abuse

[…]

(d) the following transactions:

[…]

(3)transaction, including negotiation, concerning deposit and current accounts, payments, transfers, debts, cheques and other negotiable instruments, but excluding debt collection and factoring”.

10.HMRC accept that Morpheus may rely on Article 13B(d)(3) as being directly effective, but maintain that, for the purposes of the present dispute, the exemption thereby provided for has been properly implemented in UK law. As I understand it, Morpheus accepts that it has been so implemented.

The Facts

11. I base my findings of fact on the contents of two bundles of copy documents provided by the parties, and the oral evidence of both Mr C I Harris, the legal services director of LMS and a director of Morpheus, and Mrs F Silverman, a solicitor and the author of a manual of conveyancing practice recommended by the Law Society for use by its members.

12. Morpheus is a holding company and the representative member of a group of companies treated for VAT purposes as a single taxable person within the second subparagraph of article 4(4) of the Sixth Directive. LMS is a member of that VAT group.

13.LMS’s statutory accounts describe its principal activity as “the provision of property related services”, and in its Annual Return to Companies House it discloses its business as “legal activities.”

14. In the ordinary course of business, the banks and building societies to which LMS is contracted make secured loans of money to owner-occupiers of residential properties. The security takes the form of a first mortgage on the owner’s property. Such mortgages are classified either as transactional purchase mortgages or as remortgages. A transactional purchase mortgage is one entered into by a purchaser of a property who applies the mortgage advance in whole or in part in funding his purchase. A remortgage is a mortgage entered into by an existing mortgagor on his changing from one mortgage lender to another, usually for the purpose of securing more attractive repayment and/or interest terms, or for borrowing more money. It entails the mortgagor borrowing sufficient money from the new lender or otherwise providing funds to redeem his existing mortgage. The instant case is concerned only with remortgages.

15.In the past few years the demand for remortgages has greatly increased, reaching some 1.38 million transactions in 2003. Those transactions could be dealt with by mortgage lenders in house, by a small number of very large firms of solicitors, or by a much larger number of medium sized firms of solicitors. In the instant case, the mortgage lenders have chosen the last mentioned option. To deal with the large number of independent firms of solicitors involved, mortgage lenders employ companies such as LMS to act as intermediaries between themselves and the solicitors.

16.LMS maintains a panel of solicitors’ firms able and willing to undertake the preparation of, and other legal work associated with, remortgages. It agrees a fee with a mortgage lender for each remortgage transaction irrespective of jurisdiction (England, and Wales, Scotland and Northern Ireland), which includes the associated solicitors’ fees and disbursements (such as Land Registry fees), but it is left to LMS to negotiate and agree with the individual firms of solicitors what proportion of LMS’s own fee they are to be paid for their work. And in certain circumstances the fee so agreed may exceed that due to LMS, in which case LMS must accept a loss on the transaction. As the solicitors’ fees are to be paid by the mortgage lenders, they are commonly referred to as “free legals”. LMS raises a single invoice to each mortgage lender to which it is contracted dealing with all remortgage transactions completed for it in an agreed period. On the lender paying the invoice, LMS in turn pays the solicitors involved for their work.

17.Approximately 90 per cent of remortgage transactions are classified as fast track, which means that they are intended to be completed within a very short period of time. But in order not to impose too great an administrative burden on mortgage lenders, only so many remortgages can be completed on a particular day, eg. the last day of the month. Mortgage lenders place great reliance on panel solicitors to ensure that completions take place evenly over time.

18.LMS invites the solicitors on its panel to tender for remortgage work. Based on that process, LMS renegotiates the fees charged by panel solicitors every three months, its stated objective being continually to reduce their fees. As will be seen when the terms of LMS’s contracts with individual lenders are considered, the contracts LMS has with mortgage lenders do not provide for the renegotiation of its own fees within their respective contract periods.

19.It is common ground that the services of the solicitors on the panel are made direct to the various mortgage lenders instructing them, notwithstanding that the relationships between the solicitors and the mortgage lenders are formed, arranged and managed by LMS. It is also common ground that the services supplied by the solicitors are currently standard rated.

20.A mortgage lender’s instructions are sent to whichever panel firm of solicitors is chosen by LMS to act for it. The solicitors are instructed to investigate the title to the property on which the new loan is to be secured, to make appropriate searches (except that in most cases a search of the local land charges registry is not required, the risk of its revealing anything adverse being accepted by the mortgage lender), prepare the new mortgage deed, and complete the remortgage, having discharged the existing mortgage. And, where appropriate, they must register the remortgage at HM Land Registry. Mr Harris maintained in evidence that the time allocated for investigating the title to a freehold property is 5 minutes, and that for a leasehold property 8 minutes, so that the legal input to the whole remortgaging transaction is minimal; rather it is a purely financial transaction. I shall deal with his claim in that behalf later. I shall also deal with his contentions that “the legal skill required to complete a remortgage is significantly lower than virtually all other services provided by solicitors”, and that the conveyancing process can be described “as a significant number of very simple tasks that are administrative in nature”. But in passing, I observe that no evidence was adduced of the instructions given to panel solicitors by any of the mortgage lenders, so that I am necessarily confined to dealing with his contentions on the basis of my own professional experience of conveyancing, which extended to some 30 years.

21.Apart from the fees paid to it by mortgage lenders for its own and the solicitors’ services and the disbursements, LMS handles no money for the mortgage lenders. Applications for remortgages are made direct to a mortgage lender, which processes them itself. Subsequently, on a remortgage being completed, the moneys necessary for that purpose are transferred by the mortgage lender to the solicitors concerned. They apply them in redeeming the mortgagor’s existing mortgage, and, as to any balance, act in accordance with the mortgagor’s instructions to them. If by chance the remortgage advance is insufficient to discharge the existing mortgage, the mortgagor is required to provide whatever additional moneys are necessary to redeem the mortgage, whether by borrowing (possibly from the new mortgage lender) or from his own resources. LMS plays no part in ensuring that the insufficiency of funds is remedied.

22.LMS has developed its own computer software programme, STARS, to manage and monitor the remortgage transactions in which it is instructed. STARS is continually being developed, and it is a term of LMS’s contracts with mortgage lenders that not only are they allowed to use the system, but are also entitled to take advantage of any upgrading of it which LMS may make. The STARS system is also accessible by the computer systems of many of the firms of solicitors on its panel.

23.Each firm of solicitors appointed to the panel is required to enter into an agreement with LMS which takes the following form:

Parties: 1. LMS

2. “The Solicitor” [name]

1.Introduction and Background

1.1 MS is a marketing company that specialises in marketing legal and other services.

1.2 LMS markets the services of the Panel of solicitors to obtain work for the Panel

1.3 The Solicitor wishes to be part of the Panel and benefit from the work referred to it from LMS

2. Interpretation and Definitions

2.1 In this Agreement, the following expressions shall, save where the context otherwise requires, have the following meanings:

“Panel”means the group of firms of solicitors which LMS market

“Case”a piece of legal work referred from LMS to the Solicitor

“STARS”the LMS computer system used within the LMS process

“LMS Introducer”an organisation or individual which introduces Cases to LMS

“LMS process” the method through which the Solicitor will receive instructions and communicate with LMS

3. …

4. LMS Obligations

4.1 LMS will:

4.1.1 use reasonable endeavours to market the Services of the Panel to obtain a volume of Cases to be divided between the Panel Firms.

5. Solicitor Obligations

5.1The Solicitor agrees to:

5.1.1Conduct any work referred to the Solicitor in accordance with legal best practice and at all times abide by the Solicitors Practice Rules

5.1.2 Use the STARS system

5.1.3Notify LMS within one working day of any reason why a Case cannot be serviced or progressed

5.1.4 Notify LMS within one working day if the Cases referred to solicitor are at such a high volume that the Solicitor does not have the resources to service the work expeditiously.

5.1.5 Notify LMS within five working days of being removed from the panel of any bank or building society for conveyancing transactions

5.1.6Allow an LMS compliance officer to attend the Solicitors office to inspect and remove Cases subject to the consent of the Solicitors client and the solicitors lien cost and disbursements incurred.

5.1.7Respond promptly to any reasonable request from LMS for information in respect of Cases

5.1.8 Charge only such fees notified to the Solicitor at the outset of a Case in accordance with the LMS Process

24.In connection with clause 5.1.8. of that agreement, I should explain that in certain cases the solicitors may, within the Solicitors Practice Rules, act for both the borrower and the lender, in which case any fees they may charge additional to the free legals are to be paid by the mortgagor. But unless the solicitors act for both borrower and lender, they act only for the lender.