Advocate General opinion

In O Fundusz Inwestycyjny C-250/21 the Advocate General opined that a sub-participation agree-ment did not fall within the VAT finance exemption as the transaction had a two-fold purpose of funding the principal loan and managing the creditor’s credit risk.

The case is a referral from Poland where the tax authorities had been asked to provide a tax ruling as to whether a sub-participation agreement would fall within the exemption for the granting of credit.

The sub-participation being contemplated would involve an investment fund paying a bank (the originator) an upfront amount in return for which the bank, which had lent money to a third party (the principal debtor), would agree to pay the investment fund (or sub-participant), the proceeds which it would obtain under the loan agreement with the third party. While the cash flow and the risk would be removed from the originator’s balance sheet and transferred to the investment fund, the originator would maintain legal ownership of the loan.

The Advocate General remarked at the outset of her opinion that this case was of a sensitive nature given that her answer might affect the attractiveness of such transactions.

The Advocate General noted that the sub-participation envisaged would serve a double purpose, providing liquidity for the originator and covering the originator’s credit risk in that the risk would be transferred to the investment bank. The difference between the amount paid to the originator and the amount obtained by the sub-participant in respect of the proceeds of the receivables would constitute the sub-participant’s remuneration.

From an economic perspective the Advocate General was clear that the services provided under the sub-participation agreement would constitute a financing and that a sub-participation was economically similar to a loan since the economic advantage received by the sub-participant would correspond to the mechanism of interest in a loan agreement. However, legally the original loan would remain with the originator and the sub-participation agreement would clearly define the source that would be used in satisfaction of payments to the sub-participant. In the event of default by the originator’s debtor, the sub-participant would have no claim against the originator for the remaining amounts due.

It was common ground between the parties that of all the elements of the VAT financing exemption, only the ‘granting of credit’ element was relevant. While that expression was broad enough to encompass the funding of a loan by a sub-participation, the fact that the sub-participation would be a tool for transferring credit risk (in a comparable way to a synthetic securitisation), meant that the transaction would fall outside the scope of the exemption; the two-fold purpose – funding and management of credit risk – would be indivisible services neither of which (subject to verification by the Polish court) could be regarded as either a principal or ancillary service.

The Advocate General commented that the management of credit risk might fall within another part of the finance exemption (for transactions, including negotiation but not management or safekeeping, in shares…and other securities …) but did not elaborate on this since this was not part of the question referred by the Polish court.

DLA Piper comment: An interesting case to follow for taxpayers who run such transactions with a two-fold purpose. It remains to be seen if the CJEU follows the A-G and/or provides any further guidance in this respect. The VAT finance exemption continues to be narrowly construed and the facts are always criticised in determining whether an exemption can apply. Management if credit is exempt is done by the person gaining the credit, so possibly this could apply here, if the taxpayer’s subparticipation can be treated as the granting of credit. It would have been helpful if this alternative limb of the exemption had been included in the questions referred, but it was common ground that only the grant of credit risk applied. In analysing the VAT treatment, the A-G looked through the provision of capital to analyse the purpose of the transactions, transfer of credit risk associated with exposure to underlying loans.