In the VAT practice of Costaș, Negru & Asociații, one of the recent challenges concerned the determination of the VAT exempt and VAT taxable financial services. We hereby synthetize the relevant case-law of the Court of Justice of the European Union on this topic.
I. Introduction
In an evolving economy sources of income are also becoming more diversified. Over the last decade there has been a growing trend for individuals to realize income from trading in financial instruments. These are commodities that bring significant income but are subject to financial market volatility. There is therefore a market for financial services provided in connection with these transactions. In this context, in order to avoid the laborious process of estimating the costs of each service and to make the work of tax inspectors easier, they have been exempted from value added tax.
II. The concept of financial services
The originary legal text is art. 135 paragraph 1 let. f) from the VAT Directive[1]. This text has been transposed in our Romanian Fiscal Code as well, at art. 292 paragraph (2) let. e). Essentially, these articles mention that financial-banking services, such as„transactions, including negotiation, but not management or safekeeping, in shares, interests in companies or in associations, debentures and other securities, but excluding documents establishing title of goods” are exempt from VAT.
As one can notice, this exemption is applicable to any operation which constitute an essential step in a transaction involving financial instruments (e.g. shares, titles of participations or debentures).
We do have to pinpoint that the mere occasional acquisition or holding of shares in a company does not represent an economic activity, which can grant the holder the statute of a taxable person. For a transaction to be taxable, the operations conducted by a financial instruments holder have to be a common occurance, indicating that the holder intends to obtain revenue on a constant basis from these operations. Based on the same logic, income from dividends are also not taxable, for this is obtained merel as a result of ownership of the property, and not due to an economic activity. This is applicable for negotiable securities as well.
Taking all the arguments presented above, we deduce that the VAT exemption enshrined in these articles are only applicable to legal or natural personal whose activity consists of transactioning financial instruments on a regular basis.
III. Relevant case law of European Court of Justice
Although the notion of financial services seems to be defined within the law, the definition is rather vague, as the operations listed are not circumscribed to obtaining a certain result, they are rather listed in correlation with other operations, such as transactioning and negotiating. In light of this ambiguity, through its landmark judgements the European Court of Justice has clarified this concept.
The first decision of the Court which made reference to this concept is case C-2/95, also known as the SDC case. SDC was a company which provided services in connection with the transfer of financial instruments, advice on such transactions, securities collateral and bank deposit management services. The company provided these services to banks or customers of banks, with which it collaborated indirectly, either wholly or only partially by electronic means. The services provided were comparable to other services which other financial institutions provided using their own databases. The banks paid the TCS for these services, even though the TCS acted directly for their customers. The TCS therefore acted as an intermediary between the banking institutions and their customers. The tax authorities took the view that the services provided by the SDC were not exempt from VAT and did not fall within the concept of financial services.
The Court held that the VAT exemption applies irrespective of the nature of the supplier (i.e. a banking institution or a legal person governed by private law) and the manner in which they are supplied. What is relevant for the application of this exemption is that these services have a distinct character and are specific and essential to the exempt transactions. Thus, even services involving the processing of information in connection with a transaction in financial instruments may be exempt from VAT. However, services supplying information to banking institutions or customers cannot qualify as exempt services.
Further, the European Court also ruled in the CSC case, C-235/00. In fact, CSC Financial Services acted as an intermediary for financial institutions, offering services consisting of receiving and processing customer telephone calls through a call center. In essence, CSC provided assistance to customers on behalf of the institutions with which it worked and referred requests to the financial institution for resolution where CSC’s intervention was not sufficient. However, the company did not provide financial advice and did not take part in verification or any other operations with the ultimate aim of finalizing the customer’s transaction.
The Court has been asked to clarify whether the notion of “transactions in securities collateral” includes only transactions that alter the rights and obligations of the parties by means of the transaction, or whether this term also includes services providing information to potential investors and receiving and processing applications from investors for the issuance of collateral, but without preparing and issuing the collateral documentation.
The Court applied the reasoning underlying the decision in SDC for the same reasoning. In particular, transactions concerning guarantees involving acts which have a modifying effect on the legal and tax situation of the parties can be considered to be exempt transactions. Any services of a purely administrative or technical support or physical maintenance of the system cannot be considered as financial services as they are not likely to create, alter or extinguish the rights and obligations of the parties in respect of the securities.
Furthermore, in Case C-540/09, the SEB group of companies was led by a banking institution which provided services to certain companies intending to carry out a new share issue. The services consisted in the provision of a subscription guarantee in order for the share issue to be fully liquidated. The tax authorities considered that these services did not constitute financial services exempt from VAT.
The Court of Justice of the European Union reiterates the rulings in the SDC and CSC cases, the main criterion for classifying a financial service: its capacity to create, alter or extinguish the rights and obligations of the parties. The Court has concluded that in this case the provision of a subscription guarantee is a financial service because it consists of an operation sufficient in itself to create, modify or extinguish the rights of the parties in respect of those shares/units, even if it is for the purpose of liquidating the emmission.
Case C-350/10 addressed the issue of SWFT services, which are very useful in the field of transactions in financial instruments. In short, SWIFT services are electronic messaging services for banking and financial institutions, which facilitate the exchange of financial information with the customers of these firms, using software built on the firms’ database and a secure international data exchange network.
SWIFT-affiliated banking and financial institutions access SWIFT’s services through a secure gateway and SWIFT’s pre-approved hardware. From the moment they are notified through this system, SWIFT is held responsible for sending the message and completing the transaction in accordance with the data transmitted to the banking institutions. Due to the wide range of services that SWIFT offered and the preponderance of this operator among financial or banking institutions, Nordea contracted services for a considerable amount. In accordance with the reverse charge procedure, Nordea sought to recover the VAT paid. However, these claims by Nordea were rejected by the Finnish tax authorities on the grounds that they would not be considered financial services.
The European Court concluded, however, that the services provided must be considered as a whole, having regard primarily to their purpose. In this situation, the Court held that the services offered by SWIFT cannot be considered as financial services. Even if they were the only services of that type offered on the market, and even if the service were necessary for the completion of the interbank transaction or operation, it does not fulfill any financial function in the strict sense. Thus, SWIFT offers only message transmission services between banking and financial institutions, on the one hand, and the customers of those institutions, on the other hand.
Last but not least, relevant for the definition of financial services is case C-461/12, Granton Advertising. Specifically, Granton Advertising offered transferable cards containing a discount. These could be used for partial payment for goods and services. The companies collaborated with Granton by accepting those cards for the payment of goods or services offered by them in order to attract as many customers as possible. The European Court of Justice was asked to what extent these transferable cards which enabled users to benefit from a discount when purchasing a good/service constituted financial services within the meaning of Art. 135 para. (1)(f) of the VAT Directive.
The Court has held that the notion of ‘other financial instruments’ includes any security of a comparable nature to the other securities specifically mentioned in the provision of Article 135. In the present case the Court pointed out that in reality the consumers receiving the Granton card do not have any ownership rights in Granton, any claim to Granton or any other correlative rights. The card offered to consumers was intended for the sole purpose of offering consumers a discounted price and nothing more. Thus these cards, although transferable, cannot be regarded as financial services, precisely in view of the fact that their purpose is not typical of a financial service.
From the case law of the Court of Justice of the European Union, we can outline the criteria on the basis of which a service can be considered a financial service. Thus, if the service is capable of creating, altering, or extinguishing the rights and obligations of the parties in respect of their situation in relation to shares, securities or bonds, then it will be exempt from VAT. We note that these are designed in such a way as to be able to encompass the myriad of core and ancillary services which encompass the execution of transactions and negotiations in these financial instruments.
With regard to the activity of negotiation in financial and banking transactions, it enjoys an etymological autonomy in the sense that it is closer to the concept of intermediation, but excludes purely technical, administrative or support services. As also held in the CSC case, negotiation is the activity of an intermediary who does not occupy the position of either party to a contract relating to a financial product. Negotiation is therefore a service provided and remunerated as a distinct act of mediation.
We are, however, of the opinion that the case law of the Court cannot be said to be rich or enlightening in any sense as to the nature and pattern of such financial services. We find the Court’s approach to be lax, comprehensive, precisely in view of the fact that a financial service, which includes the trading and dealing in shares, securities or other obligations, encompasses a wide range of specific services. At the same time, we believe that the Court’s generosity in interpreting this concept is also due to the fact that this field is constantly developing. Thus, new mechanisms are constantly emerging to facilitate transactions in financial instruments, which at first sight appear to have no effect on the final transaction. As uncomfortable as it may be to adapt to new economic requirements, the case law of the Court of Justice of the European Union itself requires us to interpret the concept of financial services in an evolutionary way.
Even in our company’s practice, our team has encountered difficulties in the tax authorities’ understanding of this concept. In one case, company B., which operates on the international stock exchange market, was the subject of a documentary verification. This company conducts the intermediation of financial transactions, for which it has contracted services with various contractual partners to facilitate their provision. The complexity of international stock exchange markets requires that a company’s penetration of these markets must be phased and carefully managed, therefore each contractual partner provided services for the realization of the stages of this transaction cycle, fulfilling a specific role. As an example we mention the services of a market maker, whose role is to provide bid and ask prices in the electronic trading system of a stock exchange in order to increase the liquidity of shares. Company B. did not include VAT on the invoices for these services, considering them to be exempt from VAT as they were financial services. However, the tax authorities imputed VAT liability, disagreeing with the company’s interpretation.
We argued, on the basis of the aforementioned case law, that these services play an indispensable role in the provision of services by the company, ultimately leading to the intended purpose of the transactions in financial instruments, namely the acquisition of ownership of them. In the end, the tax authorities accepted our arguments and reduced the tax liability by 90%.
IV. Conclusion
With reference to the cases before the Court of Justice of the European Union, as long as the services offered have as their purpose and result the alteration of the legal and financial reality between the parties to a transaction/trading in the fixed instruments mentioned above, they should be considered as financial services under Art. 135 para. (1)(f) and consequently exempt from VAT.
This article has been prepared for the blog of the law firm Costaș, Negru & Asociații by Ms. Diana Hoha Pop and Ms. Miruna Mihuță from the Arad Bar Association.
Costaș, Negru & Asociații is a law firm with offices in Cluj-Napoca, Bucharest and Arad, which provides assistance, legal representation and advice in several practice areas through a team of 17 lawyers and consultants. Details of the legal services and the composition of the team can be found at https://www.costas-negru.ro.
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