Another Key Defeat

PETER JENKINS discusses the High Court's decision in Commissioners of Customs and Excise v BAA plc.
AS WAS WIDELY predicted at the time, Customs have not had much luck in the courts with their highly restrictive view of the proper scope for exemption for financial services, encapsulated in the Value Added Tax (Financial) Order 1999.
Outsourcing - FDR Ltd
On the outsourcing front, the Court of Appeal judgment in FDR Ltd v Commissioners of Customs and Excise [2000] STC 672 showed that an overall service of clearing payment card transactions by a specialist centre was a single composite supply squarely within the exemption in Article 13B(d)(3) of the Sixth Directive, provided settlement services ('real' payment transfers between accounts) were included. This is notwithstanding the inclusion within the overall service of elements described in the order as 'management of credit', for example authorisations and account residency, and held by Customs to 'taint' an otherwise exempt supply and make it taxable.
The Court of Appeal did not explicitly consider the terms of the order, and the appeal concerned the 'old' law; but as the judgment was squarely based on the terms in the Sixth Directive Customs have had to concede the point more generally. The amended 'exposure clauses' for the revised Group 5 of Schedule 9 to the VAT Act 1994 are about to be published, and these, we are told, fully recognise and accept the FDR judgment.
CSC front office services
The one solace for the Commissioners has been the judgment of the European Court of Justice in Commissioners of Customs and Excise v CSC Financial Services Ltd (formerly Continuum) Case 235/001 which found that front office services, essentially of applications processing for security-based savings products such as personal equity plans, which did not involve the actual supply of the product, was not within the exemption.
This was because it was neither the exempt supply of the product itself, because what was done did not affect the legal and financial relationship of the parties concerned, i.e. the seller and buyer of the financial services, nor was it an act of mediation or negotiation, because CSC failed to qualify as an intermediary 'who does not occupy the position of any party to a contract relating to a financial product, and whose activity amounts to something other than the provision of financial services'. CSC was seen essentially as a subcontractor providing a part-service only, essentially comprising the clerical formalities relating to the contract, and was not therefore providing a service within the exemption.
BAA plc
The essential issue in BAA plc was whether the exemption for intermediary services ('negotiation' in the Sixth Directive) covered a case where the intermediary was engaged in negotiations concerning a class of contractual relationship between seller and buyer of financial services rather than individual specific contracts. In other words, it was a re-run of Commissioners of Customs and Excise v Civil Service Motoring Association [1998] STC 111 heard in the Court of Appeal, but with the benefit of the new domestic legislation introduced by the VAT (Financial) Order 1999, and developing European Court case law.
The result was the same, i.e. in favour of exemption, although to reach this conclusion Mr Justice Etherton had to conclude that the European Court had not explicitly followed and had rejected the 'narrow' view of the Advocate General on the meaning of the term 'negotiation'. CSC had failed not because of the quality of its negotiation, but because it was not in the role of an intermediary concerned with negotiation at all. As will be seen, this distinction was critical to the success of BAA plc in seeing off Customs' appeal to the High Court.
Background
In 1995, BAA plc introduced a loyalty card targeted at frequent fliers, then named BonusPoints, whereby the cardholder accumulated points on expenditure at BAA airports and, on reaching set levels of points, received vouchers for use at the airports. By 1999, when the loyalty card was renamed WorldPoints, BAA had approximately 300,000 cardholders and a database of information on the cardholders and their spending patterns.
BAA decided to offer its WorldPoints cardholders and its shareholders the opportunity to sign up for a credit card, to be named World Card, which would have a number of benefits, including the award of double WorldPoints when used at BAA airports. It sought a bank to act as issuer of the credit card.
In June 1999, BAA concluded an agreement with Bank of Scotland setting out the terms under which Bank of Scotland would issue WorldCards and the respective obligations of the parties. In summary, BAA's obligations under the contract were:
 pre-selection - identifying potential applicants from its databases;
 communication - writing to potential applicants enclosing application forms;
 endorsement - recommending the card and the WorldPoints scheme;
 processing - clerical checks to ensure that applications were completed correctly;
 communication with Bank of Scotland - forwarding completed application forms.
Bank of Scotland's obligations were:
 credit checking and final decision on issue of card;
 issue of card, processing transactions and payments on card accounts, converting value of foreign currency purchases, monitoring cardholders' payment records and dealing with overdue payments;
 all record-keeping requirements (although BAA has a right of access to ensure that it is receiving the correct amount of commission).
In return for its services, BAA receives two payments from the bank, a one-off 'introduction and processing fee' once a new card has been used for at least one month, and a quarterly commission fee calculated as a percentage of the bank's interest income from WorldCards. The agreement provides that the fees are inclusive of any VAT. The dispute concerned the VAT liability of these payments.
In 1998, the appellant opened a dialogue with Customs, and received an 'in principle' ruling in June 1998 that the payments would be exempt as the making of arrangements for the grant of credit. The appellant wrote again to Customs in June 1999, following the changes to Group 5 introduced by the VAT (Finance) Order 1999, requesting confirmation that exemption would still apply under the new legislation. Customs gave a ruling on 6 July 2000 that the appellant's services did not constitute intermediary services within Item 5 of Group 5 as amended.
Judgment in the High Court
Before the High Court, counsel for Customs, who criticised the tribunal decision as lacking clarity and proper legal analysis, submitted that the European law expression 'negotiation of credit' is restricted to the broking of an actual individual exempt transaction, and does not apply to the role of an intermediary whose role is to procure the completion of, and negotiate the terms of, a class of credit transaction on behalf of a group of potential parties to a particular transaction.
Turning to United Kingdom law, counsel for Customs argued that the services cannot constitute 'intermediary services' within Item 5 of Exemption Group 5 since they include 'promotional or similar services' and so are excluded from exemption by Note (5) to the Group. Furthermore, it was argued that the services cannot be regarded as having been supplied 'in an intermediary capacity' because they include the 'management of credit' as defined by Notes (5A) and (2B) to the Group.
In a well reasoned analysis, Mr Justice Etherton rejected the argument that the European law expression 'negotiation of credit' is restricted to the broking of an actual individual exempt transaction, noting that this argument had been clearly rejected in the European Court of Justice's reasoning in its judgment in CSC.
Customs acknowledged that the 1998 decision of the Court of Appeal in Civil Service Motoring Association was against them, but argued that that case was no longer relevant as its findings had been undermined and overtaken by the principles established by the European Court in CSC, and the change in United Kingdom law in the interim following the 1999 Finance Order. Mr Justice Etherton disagreed, noting that he saw no inconsistency between Civil Service Motoring Association and CSC in terms of their analysis of the expression negotiation of credit and therefore Civil Service Motoring Association remained a binding authority.
The judge considered that the activities of BAA were clearly the 'negotiation of credit' as they constitute a distinct act of mediation within the reasoning of the European Court's judgment in CSC, though not within the much narrower definition of the Advocate General, which the full court rejected.
Turning to the United Kingdom law, Mr Justice Etherton rejected the argument that the services provided by BAA were either clerical formalities or were promotional or similar services on behalf of the Bank of Scotland. Equally he did not accept that the services provided by BAA were the management of credit. He concluded that, on the basis of forming a view as to the overall character of the supply, the service provided by BAA was that of an intermediary service in relation to the grant of credit and that the exemption was not precluded by the exclusions in the Notes to Group 5.
The judge refused to make a referral to the European Court on the basis that the judgments of the European Court of Justice in CSC and of the Court of Appeal in Civil Service Motoring Association constitute ample guidance on the issues underlying this appeal. The judge referred the VAT tribunal decision in Institute of Directors (17503), a case on a co-branded credit card which found exemption did not apply, but noted that the case had been heard before the full European Court judgment in CSC, albeit that the decision was released after it.
Overall impact
What conclusions can be drawn from this further important defeat for Customs in the financial services arena?
First, it firmly rejects the argument which Customs have frequently tried to use that the term negotiation implies intermediation services in relation to specific transactions rather than intermediation in a class of transactions on behalf of a population of parties. To that extent, the Court of Appeal judgment in Civil Service Motoring Association is restored as soundly based case law, compatible with subsequent developments.
Secondly, the fact that the High Court was prepared to take a high level view that exemption applied on the basis of the overall character of the supply, and to disregard the application of the so-called 'tainting' provisions in Notes (2B), (5) and (5A) to Group 5 of Schedule 9, represents a major blow to what Customs were clearly trying to achieve by the changes they introduced in the 1999 Finance Order, i.e. the overturning by statute of case law precedents (including but not only Civil Service Motoring Association) with which they disagreed.
The references in the 'tainting' provisions to market research, product design, advertising, promotional etc. services were clearly intended by Customs, post-Civil Service Motoring Association, to take services of this kind provided in connection with co-branded credit cards firmly outside the exemption. In this they have failed and given the clarity of the High Court's analysis of the European law principles involved, the prospects for a successful appeal do not look good. Indeed Customs may well decide to cut their losses, particularly given the likely reaction of the Court of Appeal to a re-run of Civil Service Motoring Association.
Peter Jenkins is head of indirect tax at Ernst & Young.

Issue: 3846 / Categories: