The European Court of Justice on 27th of October released its preliminary ruling in the case C‑93/10 GFKL Financial Services AG. The main question was whether the transfer by a bank of non-performing loans to a specialist debt collector (GFKL Financial Services AG) constitutes a service for consideration and wether such consideration should be Value added taxable or should be an exempt (Sixth Value added tax Directive – Articles 2(1) and 4).
GFKL Financial Services AG is the sole and controlling member of a company incorporated under German law which on 26 October 2004 purchased from a bank mortgages on immovable property and debts relating to 70 loan agreements that had been terminated and declared mature. On the reference day, the nominal value of those debts was approximately 15.5 million Euros (EUR). GFKL Financial Services AG and the bank reached an agreement that the economic value of the debts at that time was 8 399 808 EUR. But on the day when the deal was made, the price was finally fixed at 8 034 883 EUR. The purchase agreement stipulated that, from the reference date, those mortgage rights and debts were deemed managed or held for and at the risk of the purchaser, that the purchaser was entitled to the payments attributable to the mortgage rights and debts and that liability of the seller for the recovery of the debts in question was excluded. The German tax authorities (Essen North-East Tax Office) took the position that the difference of 364 925 EUR between the economic value and the definitive purchase price of the debts should be regarded as the consideration for that service. They made a reference to European Court of Justice case (C‑305/01 MKG-Kraftfahrzeuge-Factoring) where the Court held that a factor’s guaranteeing to a client of payment of the debts by assuming the risk of the debtors’ default must be considered to be exploitation of the property. According to Essen North-East Tax Office‘s opinion, GFKL Financial Services AG had to pay German Value added tax for this transaction. GFKL Financial Services AG took the totaly different view of the situation: they assumed that as a purchaser of the debts they did not supply any service to the seller of those debts. The role of GFKL Financial Services AG was much more complex than a reciepient of assignments of debts like it is in factoring.
In previous cases European Court of Justice held that an economic activity by which a business purchases debts, assuming the risk of the debtors‘ default and, in return, invoices its clients in respect of commission (factoring), constitutes a supply of service which is subject to Value added tax. The previous European Court of Justice jurisprudence also stated that if a service is an subject of Value added tax, it must be provided in return for a consideration based on a legal relationship between the parties. In this case, there was no consideration paid by the bank to GFKL Financial Services AG for the provision of this service, because the purchaser acted on his own risk. The difference between the economic value of those debts and their purchase price reflects the actual econimic value of the debts at the time of the agreement. This results from the fact that they are doubtful and from the increased risk of default of the debtors. For this reason the difference between the values can not be interpreted as a consideration. The actual price of the contract is an object of negotiation. All things considered, that kind of economic activity can not be the subject of the Value added tax, unlike the commissions for factoring.
This judgment brought clarity to the treatment to defaulted debts transactions which has been subject to a debate for the past few years since the release of MKG-Kraftfahrzeuge-Factoring case. Moreover, European Court of Justice drew a clear distinction between factoring and debt purchasing. It has also reduced the lack of legal certainity in debt purchasing business and clarifies that parties can feel free on negotiating prices of the debt purchasing contracts. Although the decision is not suprising and does not alter the current policy on the Value added tax treatment in Lithuania.
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