HM Revenue & Customs have recently updated their VAT Notice on Finance, VAT Notice 701/49.
This notice is relevant to all business that supply or receive financial services and therefore not restricted to banks, building societies, other financial institutions or financial intermediaries.
The changes are to reflect the updates on ‘Debts and related services’ section within the Notice. The updates can be found in Section 5 of the Notice, reproduced below for your reference:
'5. Debts and related services
5.1 Sale of debts
The unencumbered sale of debt for a consideration is exempt. The value of the supply is the gross amount that the purchaser pays for the debt.
5.2 Factoring (including invoice discounting)
Factoring, including invoice discounting, is essentially a form of debt collection and is a taxable supply. However, factors and invoice discounters offer a number of services to their clients and these usually include the prepayment of part of the value of the debt. Consideration attributable to the latter is in respect of an exempt supply of credit.
5.3 The factoring process
The client assigns his debts to the factor but this is not a supply for VAT purposes. This assignment is of an equitable interest that enables the factor to fulfil his contracted functions. The factor opens a client account to which he credits the face value of the debts he has been assigned and debits his charges. These charges may be consideration for a number of standard rated administrative, clerical and accounting services. The balance, less an agreed retention, is available for the client to draw upon. To the extent to which he does so the factor debits a further charge, often described as ‘discount’. This is consideration for the exempt supply of credit.
5.4 Recourse and non-recourse factoring
The factor may operate on a recourse or non-recourse basis.
In a recourse agreement the factor will put the responsibility for bearing any loss on the client. If the debtor defaults the factor will re-assign the debt to the client.
In a non-recourse agreement the factor will accept the risk of default. A charge for this service is standard rated although it will usually be reflected within an enhancement to the administration, factoring or service charge.
5.5 VAT treatment of factoring services:
| Supply | Liability |
| Assignment or re-assignment of debt | Not treated as a supply for VAT purposes |
| Discount or interest charge | Exempt supply by the factor |
| Administration or service charge (this may cover the provision of a full sales ledger management service, credit advice, debt collection service and the provision of management information). | Standard rated supply by the factor |
| Guarantee of payment | Standard rated supply by the factor |
| Electronic transfer of funds (if charged for separately) | An exempt supply by the factor to the client |
5.6 Factoring and partial exemption
The factor will make both taxable and exempt supplies and will therefore be partly exempt. Where he provides significant administrative or accounting services to the client his standard rated supplies will allow him a high input tax recovery. Where, as in invoice discounting, the credit facility is the predominant feature of the agreement his input tax recovery will be lower.
For further information concerning partial exemption please see Notice 706 Partial exemption.
5.7 Factoring and bad debt relief
A factor cannot claim bad debt relief for debts assigned to him by his client. The client cannot claim bad debt relief for a debt assigned to a factor but can do so if the factor re-assigns the debt to him (see Notice 700/18 Relief from VAT on bad debts).
5.8 Factoring and cash accounting
Please see Notice 731 Cash Accounting for details on how to treat the debt for cash accounting purposes.
5.9 Debt negotiation
You are providing exempt debt negotiation services if you bring together the credit provider with the debtor and act between them in an attempt to mediate a change to the payment terms. However, please also read paragraphs 5.10 and 5.11.
For more information on intermediary services read section 9.
5.10 Debt collection
The supplies made by a debt collection agency, or by someone involved in debt collection, are taxable. Debt collection covers the collection of debts of any nature, even if payment of those debts has been received before, on, or after their due date.
Although debt collection service undertaken on behalf of a creditor company may involve some negotiation of the repayment of a debt by the debtor to the creditor this will not be an exempt debt negotiation service. For example if you:
- issue letters to the debtor on behalf of the creditor demanding payment, or
- seek to chase the debt in some other form (e.g. trying to contact the debtor by phone etc.), or
- seek to locate a debtor on behalf of the creditor, or
- provide accounting services to the creditor (that is you monitor the debtor’s payment account and notify the creditor of any defaulted payments)
these services will be taxable. Any debt negotiation services will be ancillary to the principal service of debt collection.
The above list is not exhaustive.
5.11 Insolvency Practitioner services
The supplies made by an Insolvency Practitioner are normally taxable.
Where an Insolvency Practitioner acts as both nominee and supervisor in any type of formal Voluntary Arrangement then the supplies by the Insolvency Practitioner are exempt.'