ECJ Ruling on VAT Treatment of Factoring Fees and Commissions

In the complex world of corporate finance, factoring offers companies immediate liquidity in exchange for transferring receivable management and risk. Nonetheless, what seems to be a seemingly straightforward exchange of invoices for cash in practice represents a labyrinth of legal and fiscal questions.

The dispute between the Finnish Tax Authorities and a Finnish factoring company highlights the tension between taxable services and VAT-exempt financing, raising fundamental questions about what constitutes a supply of services for consideration and how the intricacies of risk, remuneration, and contractual structure determine the application of EU VAT rules.

Background of the Case 

The company provides factoring services, enabling its clients to obtain immediate liquidity from receivables that are not yet due. In return, the clients transfer responsibility for managing and collecting those receivables to the factoring company. 

The factoring services are provided through two distinct factoring models. The first model is invoice factoring, which is essentially a form of credit in which the factor advances funds to the client based on the value of issued invoices, within a predefined credit limit determined by the client’s risk profile. Although the factor handles payment reminders and carries out extrajudicial collection activities, the ultimate risk of non-payment remains with the client. If the debtor fails to pay, the client bears the loss, not the factoring company.

The second model is trade factoring. In this model, the factoring company buys selected invoices from its clients up to a maximum amount, again set according to an assessment of the client’s business risk. In contrast to invoice factoring, the receivables are fully assigned to the factor, and with that assignment comes the transfer of the risk of default. If the debtor does not pay, the loss is borne by the factoring company rather than the client.

The agreements between the company and clients provide for the payment of several types of fees and commissions, including factoring commission, which is paid in advance and calculated as a percentage of each assigned debt. The amount of this commission is not fixed and varies with risk-related factors. 

The lower the client's and the underlying debtor's credit rating is, and the longer the agreed invoice payment period is, the higher the commission becomes. Additionally, clients may be required to pay arrangement fees and a range of other ancillary expenses and costs.

The issue arose when the Finnish Central Tax Authority issued an advance tax ruling covering the period from late October 2022 to the end of 2023, stating that the commissions and fees received by the factoring company in connection with both invoice factoring and trade factoring are subject to VAT. The main reason for this conclusion was the Tax Authority's interpretation that it represents consideration for services involving the management and collection of receivables linked to invoices.

However, for factoring commission, together with specific other fees and costs, the Tax Authority concluded that they should be regarded as remuneration for a financial service that is exempt from VAT.

The company challenged this interpretation before the Supreme Administrative Court, requesting the partial annulment of the advance ruling. The factoring company argued that the factoring commission and all related expenses and fees should be treated as entirely subject to VAT. Moreover, the company stated that only the so-called underwriting fee, calculated as a percentage of the financing limit made available to each client, could qualify as consideration for a VAT-exempt financial service linked to the granting of credit.

After carefully examining all the merits of the case, as well as particulars of the services that the company provides, the Court noted that factoring may partly constitute a financing service, particularly in the context of invoice factoring, where the provision of credit is separate from the management or collection of debts, which is subject to VAT. 

In such cases, the financing element and the VAT-taxable service could be seen as distinct components rather than a single, indivisible supply. The Court also added that, while Final Law, not only the granting of credit but also other forms of financing arrangements, are exempt from VAT, the EU VAT Directive does not explicitly refer to these broader financing arrangements.

Based on its findings, the Court sought a preliminary ruling from the Court of Justice of the European Union (ECJ) concerning the factoring commission and arrangement fees, adding that an analysis of the VAT treatment of these amounts will be sufficient to determine the correct treatment of all other related costs and fees charged in connection with the factoring services. 

Main Questions from Request For Ruling

The court raised five questions before the ECJ concerning the VAT treatment of fees charged in connection with both trade factoring and invoice factoring. With the first question, the Court asked whether, in trade factoring, the factoring commission should be treated as an adjustment to the purchase price of the debts and therefore outside the scope of the VAT Directive, or whether it constitutes consideration for a supply of services subject to VAT. 

Additionally, it sought guidance on whether the fixed arrangement fee for setting up and activating the trade factoring arrangement falls within the scope of VAT.

Further, the Court asked whether, if these fees are considered payment for services under the VAT Directive, they might be exempt under provisions relating to the granting of credit or financial transactions concerning payments or debts, or whether they should be treated as taxable consideration for debt collection or another taxable service.

Regarding invoice factoring, the Court asked whether the factoring commission and the arrangement fee should be treated, at least in part, as consideration for a tax-exempt financial service under the VAT Directive, or whether they are taxable as payment for debt management or other services.

Finally, the Court raised the question of direct effect, asking whether, if the fees are fully taxable under the VAT Directive, that treatment is sufficiently clear and unconditional to be directly applicable, even where national law exempts not only the granting of credit but also other financing arrangements.

Applicable EU VAT Directive Article

Regarding the key provision of the EU VAT Directive, the ECJ identified Articles 1(2), 2, 9, and 135(1) as the most relevant. Article 1(2) establishes the foundational principle of the EU’s common VAT system, Article 2 clarifies the scope of VAT, and Article 9 provides a definition of a taxable person. 

Article 135(1) provides certain exemptions from VAT, including for the granting, negotiation, and management of credit by the person providing it, and for transactions related to deposit and current accounts, payments, transfers, debts, cheques, and other negotiable instruments, explicitly excluding debt collection.

Finland National VAT Rules 

As noted by the ECJ, under the Finnish VAT Law, VAT is levied for the benefit of the State on the sale of goods or services carried out in Finland in the course of business. However, certain exemptions apply to the sale of a financial service, including the granting of credit and other financing arrangements, as well as the management of credit by the provider. 

Importance of the Case for Taxable Persons

The raised question, the ECJ's interpretation, and the cited established case law clarify how VAT applies to complex financial arrangements, such as factoring, where services often combine elements of credit provision and debt management. For businesses providing or using such services, the case highlights the need to carefully distinguish between VAT activities and potentially VAT-exempt financial services, as the classification directly affects tax liability.

Analysis of the Court Findings

The ECJ considered the first and second questions together, and interpreted them to ask whether, in trade factoring, the factoring commission and the arrangement fee paid by the client should be regarded as consideration for a supply of services subject to VAT under the EU VAT Directive. 

For a supply of services to be considered carried out for consideration, a legal relationship between the service provider and the recipient that involves reciprocal performance must exist, and the remuneration received by the service provider must reflect the value actually given in exchange for the service supplied. Additionally, the ECJ recalled that in previous interpretations it held that a genuine factoring activity, in which the factor purchases debts owed to a client without a right of recourse, constitutes a supply of services for consideration. 

In such arrangements, the factor relieves the client of the burden of debt recovery operations. It assumes the risk of non-payment, while the client pays the difference between the face value of the assigned debts and the amount paid by the factor. This reciprocal arrangement, involving a clearly defined service in return for a payment, meets the criteria for a supply of services under VAT.

Since trade factoring in the present case shares essentially the same characteristics as the genuine factoring described in earlier rulings, the ECJ concluded that services provided in this context constitute a supply of services for consideration.

The ECJ also noted that, in the present case, trade factoring involves debts that are not yet due and for which there is no a priori reason to doubt full repayment. Additionally, trade factoring cannot be treated as a simple transaction akin to acquiring and holding shares outside the scope of VAT. The factor does not act as a passive owner of the purchased debts. Still, it actively provides a service by assuming, for remuneration, the risk of non-payment by the debtors, thereby creating a taxable supply of services under the VAT Directive.

Regarding whether, in trade factoring, the factoring commission and arrangement fees paid by the client constitute consideration for services, the ECJ stated that given the fact that commission is calculated as a percentage of the debts, determined not by their actual economic value but by the credit rating of the debtors and the length of the remaining payment term, it cannot be viewed as merely an adjustment to the purchase price of the debts.

On account of the third and fourth questions, the ECJ considered them together as well, understanding them as asking whether the factoring commission and arrangement fees paid by the client in a trade factoring context should be treated as consideration for a single, indivisible debt collection service subject to VAT, or whether part of those fees should be regarded as remuneration for a VAT-exempt service related to the granting of credit.

Under the established case law, the exemptions provided in Article 135 must be interpreted strictly, as they constitute exceptions to the general principle that VAT applies to all services supplied for consideration by a taxable person. Given that the exemptions do not explicitly include debt collection, that concept must be understood in context and interpreted in light of the overall purpose and structure of the EU VAT Directive.

Thus, based on the previous ruling, the ECJ stated that debt collection refers to financial transactions aimed at securing payment of a pecuniary debt, including all forms of factoring, regardless of their structure. As noted earlier, trade factoring in the present case shares the same characteristics as genuine factoring, which falls under the scope of the concept of debt collection. Notably, the same reasoning applies to invoice factoring.

Additionally, after referring to case law as well as after a detailed analysis of both factoring models, the ECJ determined that, in the context of invoice factoring, the factoring commission and the arrangement fees paid by the client constitute consideration for a single, indivisible supply of debt collection services and are therefore subject to VAT.

Regarding the final, fifth question, the ECJ emphasized that a provision of EU law is unconditional where it lays down an obligation that is not subject to any condition and does not depend, as to its implementation or effects, on the adoption of further measures by either the EU institutions or the EU country. Conversely, it is sufficiently precise in setting out that obligation in clear and unequivocal terms, enabling individuals to rely on it and national courts to apply it.

Based on the wording and the purpose of Article 135, the exception relating to debt collection has a direct effect and may therefore be relied upon by individuals before national courts. Considering the principle of primacy, national courts must reject any national legislation or practice, even if adopted subsequently, that is contrary to a directly effective provision of EU law, without being required to seek or await the prior repeal of such legislation or practice by legislative or constitutional means.

Courts Final Decision

Although the Court referred five questions to the ECJ, the ECJ grouped them into three key questions and delivered its final judgment on these three. 

Therefore, the ECJ concluded that in the case of trade factoring, both the factoring commission, whose amount reflects the length of the payment period and the level of risk assumed, and the arrangement fees paid by the client to set up the factoring relationship, including costs linked to compliance with anti-money laundering obligations, represent consideration actually received in return for a supply of services falling within the scope of the VAT Directive.

Furthermore, in both trade factoring and invoice factoring, the factoring commission and the arrangement fees together constitute consideration for a single and indivisible debt collection service. Consequently, they are subject to VAT and do not qualify for the exemption applicable to the granting of credit.

Finally, the defined exception relating to debt collection is unconditional and sufficiently precise to have direct effect. As a result of this conclusion, it may be relied upon by individuals before national courts in proceedings against the governing bodies.

Conclusion

In the end, the ECJ ruling confirms that both trade and invoice factoring involve the supply of a single, indivisible debt collection service for consideration, meaning that the factoring commission and arrangement fees paid by the client fall within the scope of VAT and are taxable. 

For taxable persons, this decision underscores the importance of carefully identifying the nature of the services provided, the economic reality of transactions, and the corresponding VAT treatment, reinforcing both compliance obligations and the potential to assert EU law rights directly before domestic courts.

Source: Case C-232/24 - A Oy, EU VAT Directive