As the new year of 2024 begins, we have reflected on some of the key VAT issues faced by building societies to keep in mind for the year ahead.
Loan administration services
In October 2023, the Supreme Court released the Target decision confirming that third party loan administration services cannot be VAT exempt where the loan was created before the third party’s involvement. Considering the direction of recent caselaw has moved towards a narrow interpretation of the exemption, the outcome of this decision is perhaps not unexpected. However, this decision does not address the wider uncertainties in the VAT treatment for businesses who have alternative structures in place to service lenders in respect of the loan administration.
Whilst the case provides more clarity on the boundaries of exemption, it does raise the question of the extent to which this will increase inefficiencies and costs in a supply chain involving exempt financial services in the UK.
As a result of the decision, any building societies receiving supplies of loan administration services may incur a VAT cost which could be irrecoverable. It is therefore worth checking whether the relevant supplier contracts quote fees as VAT inclusive or VAT exclusive to understand whether an additional VAT charge will apply historically (if VAT has not been charged to date). If any such supplies are received from overseas suppliers, recipients will need to consider any obligations under the reverse charge. It is also worth considering whether alternative structures would be beneficial.
A service that is provided for no consideration (monetary or non-monetary) is not a supply for VAT purposes. Therefore, often businesses providing services free of charge will treat their supplies as outside the scope of VAT. However, when services are provided free of charge, it is important to ensure that there is no non-monetary benefit being received in return for the services provided. If services are provided in exchange for a non-monetary consideration then there could be a barter transaction in play which would bring the supplies within the scope of VAT. In recent times, HMRC have considered this aspect for businesses in financial services. As such, if building societies that supply services free of charge do not treat their supplies as being within the scope of VAT it is worth reconsidering whether there is any non-monetary being received and the corresponding VAT consequences, particularly if the VAT position has not been considered for some time.
Many building societies are partially exempt, meaning they must restrict their VAT recovery to reflect the use of costs used in making VAT exempt supplies; the standard method of doing so is by considering the ratio of taxable and exempt income values. A PESM (partial exemption special method) is an agreement with HMRC that allows a partially exempt taxpayer to apply a bespoke methodology to recover its input VAT. A PESM must be approved by HMRC before it is used.
In 2023 we have noted an increased delay in PESM negotiations with HMRC; where previously we would have expected PESMs to be agreed within a matter of months we are now seeing this process take years. This appears to be due to changing HMRC policy and approach, resulting in HMRC challenging methodologies that have previously been widely accepted in the financial services sector, in particular:
- Many financial services businesses opt to use a transaction count-based apportionment rather than using transaction values (i.e. moving away from the standard method). HMRC now appear to more strenuously test why the use of a values-based method is not fair and reasonable before accepting alternatives.
- HMRC previously preferred aligning the PESM with cost allocation methods used in business’s management accounts, as this suggested that the PESM reflected how a business used its costs from a commercial perspective. However, as these management account allocations can rely on management estimates as opposed to auditable data, the use of such allocations is now being scrutinised.
The drawn-out negotiation process can result in increased administration and costs for businesses, and uncertainty on their expected VAT recovery position. It is therefore essential that any new PESM proposals consider and pre-empt potential HMRC queries to ensure the PESM negotiation process can be concluded as swiftly as possible.
To find out more:
or email Tina.Warhurst@bdo.co.uk