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FREE: European court’s opinion on debt recovery favours taxpayer

A German company will not have to pay VAT on its acquisition of distressed debt, if the opinion of an Advocate-General is followed in Finanzamt Essen-NordOst v GFKL Financial Services AG (C‑93/10) at the European Court of Justice.

In the view of Advocate-General Jääskinen, GFKL’s purchase of a portfolio of defaulted debts constitutes a service and an economic activity, which would make it subject to tax under the scope of the EU’s Sixth VAT Directive. However, he felt there was no direct link in this situation between the service provided and the consideration received and that meant the directive should not apply.

Jääskinen opined that GFKL was providing a service to the bank over and above buying the portfolio of debts. He argued that the service was the fact that GFKL was the debts off the bank’s hands and relieving it of the problems associated with collecting them. He concluded that if a service existed so did an economic activity.

However, the Advocate General explained that for the directive to apply the consideration needed to be paid in return for a service, otherwise known as the direct link requirement. GFKL paid less than the face value of the debts. In Jääskinen’s view, GFKL paid the lower amount because of the risk attached to recovering the debts, not for the cost of the service it was providing to the bank, so there was no direct link.

In October 2004 GFKL paid the unnamed bank €8,034,883 for a portfolio of mortgages on immovable property and debts arising from 70 terminated and matured loan agreements. The debts had a face value of €15,500,915.16.

GFKL believed that as an acquirer of the debts, it did not supply a service to the seller which is liable to VAT. At the same time, it submitted a provisional tax return after the Bundesministerium der Finanzen, German Federal Finance Ministry, announced in June 2004 that it intended to implement the judgment in MKG, where the Bundesfinanzhof had decided that a business that purchased debts was not exempt from VAT because it was engaged in debt collection and factoring.

When the Finanzamt Essen-NordOst dismissed GFKL’s objection to its provisional VAT assessment. the taxpayer appealed to the Finanzgericht (Finance Court) and won, the court ruling that the transfer of defaulted debts did not constitute a service for the seller that was liable to VAT.

Three questions for ECJ

The case went to the Bundesfinanzhof, who referred three questions to the ECJ covering a service for consideration and economic activity; whether the assumption of the risk of loss is exempt from tax and whether the recovery of the debts is exempt from tax as a single service and whether the consideration is determined by the recovery costs agreed between the parties or the actual recovery costs.

Having giving his opinion on the question about consideration and economic activity, Jaaskinen felt he did not have to answer the other two, but did anyway. He determined that the situation in the case amounted to debt collection and was therefore not exempt from VAT. He also opined that the consideration 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.

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