The Court of Justice of the European Union (the “CJEU”) held on 6 October 2022 in O. Fundusz lnwestycyjny zamknięty reprezentowany przez O S.A. (Case C-250/21) (the “O Fundusz case”) that the supply of services provided by a sub-participant under a sub-participation agreement falls within the “granting of credit” exemption under Article 135(1)(b) of the VAT Directive. This departs from the Advocate-General’s opinion (the “AG Opinion”), which we have written about previously here.

LMA-style funded sub-participation

The sub-participation agreement in the O Fundusz case aligns with the arrangement under the standard form LMA funded sub-participation documentation.

The facts underlying this decision are the same as those underlying the AG Opinion. As a refresher, we have summarised the facts below.

According to the sub-participation agreement in question, the sub-participant pays the grantor an upfront amount upon the conclusion of that sub-participation agreement. In return for that payment, the grantor, which has lent money to the underlying debtor, agrees to pay the sub-participant the proceeds obtained by the grantor under the original loan agreement with the underlying debtor. While the cash flow and the risk are removed from the grantor’s balance sheet and transferred to the sub-participant, the original loan agreement remains in the assets of the grantor. The mechanism of the sub-participation, therefore, fulfils a dual function – firstly, that of a credit instrument; and secondly, that of risk cover.

The CJEU considered whether the supply made by the sub-participant is effected for consideration, and, if so, whether such supply falls within the scope of the “granting of credit” exemption under Article 135(1)(b) of the VAT Directive. We consider each of these points below.

The supply is effected for consideration

The CJEU agreed with the AG opinion that the supply is effected for consideration. Under a sub-participant agreement, the sub-participant undertakes to make a financial contribution available to the grantor, and the grantor undertakes to transfer to the sub-participant the proceeds from the receivable specified in that agreement, while retaining the original loan agreement in the grantor’s assets. In other words, the grantor receives a service in return for consideration, which corresponds to the difference between the estimated value of the proceeds from the receivable and the amount of the financial contribution paid by the sub-participant.

The CJEU distinguished the O Fundusz case from GFKL Financial services (C-93/10) (the “GFKL case”). The CJEU in the GFKL case held that an operator who, at his/her own risk, purchases defaulted debts at a price below their face value does not effect a supply of services for consideration when the difference between the face value of those debts and their purchase price reflects the actual economic value of the debts at the time of their assignment. The CJEU distinguished the O Fundusz case from the GFKL case on the basis that the sub-participant does not purchase at its own risk defaulted debts at a price below their face value and that the amount of the financial contribution made available to the grantor is generally determined differently from the price paid by an assignee for the assignment of claims.

Granting of credit

Although the CJEU noted that the “granting of credit” should be interpreted strictly, the CJEU held that the requirement of strict interpretation does not mean that the term should be construed in such a way as to deprive the exemption of its intended effect.

The CJEU recalled that the granting of credit, within the meaning of Article 135(1)(b) of the VAT Directive, consists of the provision of capital against remuneration.

The CJEU held that the service provided by the sub-participant to the grantor under the sub-participation agreement is made up of a single supply, i.e., a payment of capital in return for remuneration. The remuneration here is the difference between the estimated value of the proceeds from the receivable and the amount of the financial contribution paid by the sub-participant.

Importantly, the CJEU differed from the AG Opinion. The AG Opinion suggested that the transfer of credit risk from the grantor to the sub-participant is one of the two indivisible services provided by the sub-participant to the grantor and that the transfer of credit risk could not be interpreted as “granting of credit.” However, the CJEU held that the fact that the sub-participant is exposed to potential losses, and thus bears the credit risk, is inherent in any grant of credit, regardless of whether that risk stems from non-payment by the underlying debtor or from the insolvency of the grantor.

The CJEU also held that the form of consideration, the status of the entity providing those services, and the absence of guarantees provided in favour of the sub-participant are all irrelevant. Similarly, the essential nature of a sub-participation transaction is not affected by the fact that the sub-participant has no legal remedy against the grantor in the event of default by the underlying debtor, the fact that the original loan agreement remains in the grantor’s assets, or the fact that the source of the capital which will be used to satisfy the sub-participant’s claims is mentioned in the sub-participant agreement.

Lastly, the CJEU considered that this interpretation is consistent with the objective pursued by the “granting of credit” exemption, which includes avoiding an increase in the cost of consumer credit.

Therefore, the CJEU held that the services provided by a sub-participant under a sub-participation agreement fall within the “granting of credit” exemption.

Conclusion

This CJEU’s decision is welcomed. It aligns with the market’s expectation that there should not be any VAT chargeable in a sub-participation transaction. In a UK context, although the O Fundusz case is no longer binding on UK courts after Brexit, this decision can be persuasive, as the current UK VAT provisions were originally transposed from the VAT Directive.