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SWIFT Services: Do Not Qualify for EU VAT Exemption

14 Sep 2011

In its judgment on 28 July 2011 (Case C-350/10, Nordea Pankki Suomi Oyj) the ECJ ruled that SWIFT services are not VAT exempt. SWIFT (Society for Worldwide Interbank Financial Telecommunication "SWIFT") is the global provider of secure financial messaging services through which financial institutions process payments and securities transaction orders are transmitted from one financial institution to another in a secure and reliable manner.

The conclusion reached in the judgment goes against the current approach in some EU Member States. The fact that SWIFT services are not VAT exempt has a direct impact on the profit and loss accounts of the recipients, insofar as they are not entitled to full VAT recovery. Furthermore, the judgment revisits the exemption requirements for outsourced services in the financial sector and its reasoning may be applied to other services of a similar nature.

Services outsourced by financial institutions may be exempt. However, in order for them to qualify they have to be capable of altering the legal or financial position of the banks vis-?-vis their clients. What's more, they cannot be limited to the technical aspects needed to carry out the financial transactions.

Taxand Spain analyses the ECJ ruling exempting SWIFT services for financial institutions from VAT and its impact on the financial sector.

According to EU case law, exemptions must be interpreted strictly. Nevertheless, there is nothing to prevent SWIFT services that are outsourced by financial institutions from benefitting from the exemption. For such purposes, the outsourced services must form a distinct whole, fulfilling in effect the specific, essential functions of the exempt financial transactions.

Since its judgment of 5 June 1997 (in Sparekassernes Datacenter (SDC) v Skatteministeriet, Case C-2/95), the ECJ has used a two-fold test for outsourced services to qualify for the exemption:

1) their supply must be capable of giving rise to changes of a legal and financial nature, similar to those resulting from the financial transaction itself; and

2) the responsibility of the service provider towards its clients must not be limited to technical aspects but must extend to specific, essential aspects of the financial transaction.

To determine whether SWIFT's services constitute a distinct whole, fulfilling in effect the specific, essential functions of payments or securities transactions, the ECJ reviews the functions performed. It considers that, in this case, they are simply intended to transmit information, but they do not, per se, perform any of the functions of a financial transaction. Even if they were essential services, and the only services available to carry out the transactions, this fact alone would not suffice to qualify them as exempt. As it is only the banks that transfer ownership in funds or securities, the services supplied by SWIFT are therefore not capable of giving rise to changes of a legal and financial nature between the banks and their clients.

Regarding the responsibility of the service provider, its contractual obligations are limited to the technical aspects of the messaging service, in particular, implementation, activation, connection, maintenance and software licenses. SWIFT is thus only responsible for the correct transmission of financial messages via the approved computer system. Its obligation is to ensure the security and legibility of the data transmitted and to make good any damage caused by defective or delayed data transmission. It does not extend to specific, essential elements of the financial transactions and cannot, therefore, be included within the scope of the exemption.

Taxand's Take

EU legislation on exemptions of financial transactions suffers from a lack of detail in its wording and has clearly been overtaken by market developments since being introduced in 1977. As a result, administrative and business practices, and even national laws transposing such legislation, have adopted different solutions for the definition, scope and application of the exemptions in the different Member States. Without prejudice to the changes envisaged in the proposed Directive which, if finally approved, may help to mitigate this situation, it is the ECJ that has gradually fine-tuned the scope of some of the EU provisions, affecting many of the criteria traditionally applied at national level.

A good - but not the only - example of this is referred to here in connection with the outsourcing of services and the criteria to qualify for the exemption. The SDC judgment seemed to pave the way for the efficient use of outsourcing. Now with the Nordea judgment the Court has made it clear that the exemption criteria may also have a negative impact in some Member States on services that were traditionally considered exempt.

The Court advises that financial institutions' inputs be revisited, to determine nondeductible VAT costs as clearly as possible and ensure that the tax is managed correctly.

This analysis would need to be conducted at a national level and in particular ahead of the reactions of the tax authorities of the Member States depending on whether application of the VAT exemption to SWIFT services results from domestic legislation (in which case it would be limited by prohibition of the inverse direct effect), from administrative practice (in which case the legitimate expectation of taxpayers must be safeguarded) or from simple business practice. The analysis (and the reaction of the tax authorities) depends on the specific situation in each country.

Your Taxand contact for further queries is:
Carlos G?mez Barrero
T. +34 91 514 54 21

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