MBNA Europe Bank Ltd v Revenue and Customs [2006] UKVAT V19413 (18 January 2006)
19413
VAT — input tax — credit card bank — partially exempt trader — agreed special method and regulation 103 agreement for attribution of residual input tax — securitisation of credit card receivables — assignment of receivables to Jersey receivables trustee — trustee holding assigned receivables on trust for Jersey company which issued loan notes on security of receivables — whether assignment capable of amounting to supply by bank or merely security for loan — whether withdrawal of agreed special method and regulation 103 agreement valid — assuming assignment was supply for VAT purposes whether they and servicing of them made at fixed establishment of receivables trustee in UK — whether assessments to tax should be reduced — whether servicing of customers' accounts uses residual inputs — assuming it does, whether full servicer fee should be included in calculation or a lesser proportion — whether share of servicer fees attributable to non-designated accounts should be excluded from contractual amount — how should servicer agreement be construed as to its scope, and administering and collecting of receivables — whether when used as proxy servicer fees also suffer from further flaw of being unreliable — whether agreed method and agreement should be construed as excluding receivables on accounts not designated at time returns made but designated before paid — whether voluntary disclosure in part out of time as having been made more than 3 years after end of relevant accounting periods — Sixth VAT Directive, arts 9, 11, 13, 17 and 19 — VATA 1994 ss. 4, 9, 24, 26, Sch 9 Gp 5 VAT Regs 1995, regs 29, 35, 101, 102 and 103 — VAT (Input Tax) (Specified Supplies) Order 1999, arts 2 and 3.
MANCHESTER TRIBUNAL CENTRE
MBNA EUROPE BANK LIMITED Appellant
- and -
THE COMMISSIONERS FOR
HER MAJESTY'S REVENUE AND CUSTOMS Respondents
Tribunal: David Demack (Chairman)
Mrs Catherine Farquharson
Mrs Lynneth Salisbury
Sitting in public in London between 26 and 30 September and 3 and 6 October 2005
Roderick Cordara QC and Mark Smith, of counsel, instructed by Messrs PricewaterhouseCoopers, chartered accountants, for the Appellant
Nicholas Paines QC and Peter Mantle, of counsel, instructed by the Acting Solicitor for HM Revenue & Customs for the Respondents
© CROWN COPYRIGHT 2005
DECISION
Introduction
- The appellant company, MBNA Europe Bank Ltd ("MBNA"), trades as a bank making exempt supplies of credit. It also makes other supplies, some of which are taxable. Consequently, it is a partially exempt trader.
- Partially exempt traders are able to recover only part of the input tax they incur. That attributable to taxable supplies, which they make or intend to make, they can recover in full; that attributable to their exempt supplies, they cannot recover; and that which cannot be directly attributed to taxable or exempt supplies or intended supplies, is residual input tax of which they can recover in part. To determine that part such a trader must attribute his inputs in some way, dividing them between deductible uses and non-deductible uses.
- Section 26 of the Value Added Tax Act 1994 ("VATA") provides that so much of a taxable person's input tax is allowable as is attributable by or under regulations to (1) taxable supplies; (2) supplies outside the United Kingdom which would be taxable supplies if made in the United Kingdom; and (3) other supplies made outside the United Kingdom and such exempt supplies as may by order be specified. By section 26(3) of VATA, the Commissioners of Her Majesty's Revenue and Customs ("the Commissioners") are required to make regulations for the fair and reasonable attribution of input tax. Those regulations are to be found in Part XIV of the VAT Regulations 1995 ("the Regulations"). (All references to regulations 101, 102 and 103 in this decision without more are to the regulations so numbered in those Regulations.) Regulation 101, implementing article 17(5) and 19 of the EC Sixth VAT Directive (EEC/77/388), employs use as the primary method of attribution, and regulation 101(d) provides a standard method of determining the extent of use based on turnover values. As that method may not exactly reflect how dual-use supplies are in fact used, regulation 102 permits the Commissioners to approve or direct the use of a method other than that specified in regulation 101 to attribute residual input tax. Such a method is referred to as a "partial exemption special method" ("PESM"). An approved or directed PESM stands in place of the regulation 101 method for any trader. Most PESMs direct attribution to the greatest extent possible, in effect repeating the standard method so far as the attribution of inputs to standard-rated and exempt supplies is concerned. Where they differ from the standard method is in relation to residual input VAT, being directed primarily to allocating and apportioning it fairly and reasonably by means of a proxy for "use".
- In the case of Customs and Excise Commissioners v Liverpool Institute of Performing Arts [2001] STC 891 ("LIPA"), the House of Lords decided that the method of attribution provided by regulation 101 applies only to UK taxable supplies, thus leaving attribution of dual-use out-of-country supplies and other specified supplies to be dealt with in some other way. (The phrase "out-of-country supplies" was coined by the House of Lords in the LIPA case to describe supplies of services made to overseas recipients).
- Regulation 103 deals with out-of-country supplies by establishing a code separate from that in regulations 101 and 102 directing that input tax used or to be used in whole or in part in making out-of-country and specified supplies "shall be attributed to taxable supplies to the extent that the goods and services are so used or to be used expressed as a proportion of the whole use or intended use". Again "use" is not defined, so that a suitable proxy for it must be found. It is common ground that the Commissioners may, in a single letter, enter into a PESM and an agreement under regulation 103.
- Having explained how the domestic legislation deals with residual input tax, we shall now outline the facts of and in relation to certain residual input tax claims made by MBNA with particular reference to the money-raising process known as securitisation, those claims being the subject of the appeals. Then we shall present the facts in detail before describing the law and setting out our conclusions.
The facts in outline
- MBNA enters into credit agreements with and provides credit card facilities and makes personal loans to customers. It raises some of its working capital from investors who wish to invest money in the bond markets by means of a process known as securitisation. That involves it equitably assigning some, but not all, credit card debts owing, and to become owing, to it to a Jersey based registered trust company it has created. The trust company used in MBNA's current series of securitisations is Credit Card Securitisation Europe Limited ("CCSE"), which is known as the receivables trustee. (In an earlier series of securitisations the receivables trustee was Credit Card Securitisation International Ltd ("CCSI"). For convenience throughout the remainder of our decision, except as otherwise plainly stated, all references to CCSE shall include CCSI). CCSE's capital is owned by a Jersey registered charitable trust. The debts owing, and to become owing, to MBNA are divided into three categories of "receivables". Existing debts are known as existing receivables, those to become owing as future receivables, and the interest and charges on the account as finance charge receivables. The trust capital consists of moneys provided by MBNA and receivables assigned to the trust. CCSE holds the trust capital on a bare trust for MBNA itself and one or more of three other beneficiaries, known as investor beneficiaries, of which Deva One Limited is currently the only active one. Deva One Limited, like CCSE, is Jersey registered, and was created by MBNA. Its capital is owned by the same charitable trust as owns CCSE's capital. Deva One Limited issues loan notes to financial institutions using its interest in the trust as security. The borrowed money is paid to CCSE which then pays it to MBNA. The institutions in turn issue interest-bearing paper coupons to the ultimate providers of the money raised by securitisations. CCSE and Deva One Limited are special purpose vehicles, or SPVs. SPVs are required to have no discretion by US regulators, i.e. they must do what is demanded of them by MBNA and thus protect the receivables from MBNA's, insolvency (US regulations are relevant as a result of MBNA being a subsidiary of an American Bank). The purpose of SPVs is to distance the money raising operation from MBNA's creditors in that hypothetical event. That enables MBNA to raise money on the money markets on the security of receivables at a rate of interest lower than MBNA would itself have to pay. (The risk is attached to the receivables as opposed to MBNA). Credit card holders' accounts which have been securitised are known as designated accounts. As holders of designated accounts pay their monthly bills, the receivables become "collections" and are replaced by new receivables, and the process is then repeated. The collections are repaid to MBNA providing it with "revolving" funds. The funds do not revolve for ever, being arranged for a specified term, and are eventually repaid to the coupon holding investors by MBNA in what is known as the "amortisation" period. Following a securitisation, MBNA continues to service both designated accounts, and non-designated accounts. For its work in servicing the designated accounts, for obvious reasons called servicer services, it is paid fees by CCSE.
- On 19 November 1999 MBNA entered into what, following the LIPA case, is now recognised to have been a combined PESM/agreement under regulation 103 ("the Agreed Method") under which it could recover residual input tax applying the fraction:
Value of taxable supplies (including specified supplies)
Value of all supplies
subject to certain exclusions set out in paragraph 3 of the Agreed Method
The exclusions relevant to the appeal were (1) sums receivable from the assignment of receivables, and (2) sums receivable from cardholders whose accounts "at that particular time" had not been securitised. It was expressly stated that the value of supplies of servicing designated accounts was not excluded. Thus the Agreed Method was a proxy for the values of outputs.
- As the Commissioners concluded that the Agreed Method was flawed and not producing a fair and reasonable result (if only because, in their opinion, it wrongly excluded the value of supplies to securitised cardholders whose accounts had been designated ("designated cardholders") from the denominator of the fraction, thus wrongly inflating the recovery proportion), they withdrew it with effect from 1 July 2003, and did not replace it. Nevertheless, MBNA initially continued to apply it. But from about December 2003, it acted upon the withdrawal, although disputing it. Having recognized the need to carry out separate attributions under regulations 101 and 103, it thereafter performed a separate calculation under regulation 101 for the determination of its receivables input relating to its in-courntry supplies. But, when making claims under regulation 103, it continued to apply the Agreed Method, including the express exclusions. MBNA modified the Agreed Method in only one respect (made inevitable by the regulation 101 calculation), namely by removing the value of taxable supplies, but continued to exclude the value of supplies to designated cardholders. The Commissioners assessed MBNA to the tax arising from withdrawal of the Agreed Method and its continued application by the company.
- On 31 July 2003, MBNA made a voluntary disclosure claiming repayment of £8,964,427 input tax in the monthly accounting periods April 2000 to March 2003 inclusive. In a letter accompanying the disclosure, its representatives contended that it had previously misconstrued the Agreed Method and had wrongly included in its calculations interest and certain other charges made on cardholders but not actually received before those cardholders' accounts had been securitised, so it claimed erroneously to have included sums receivable from cardholders whose accounts "at that particular time" had not been securitised. The Commissioners refused to act on the voluntary disclosure.
The case for each party in summary
- At the outset, since each party claimed to have difficulty in understanding the approach of the other to certain aspects of the case, we required them to summarise their cases. The following summaries were produced to us.
- MBNA claims that:
a) its equitable assignments of receivables are sales, and thus supplies for VAT purposes;
b) such sales, being to a company belonging outside the European Union, are specified supplies;
c) supplies of servicing receivables are similarly specified supplies;
d) the residual inputs on the supplies at (b) and (c) above, being attributable to specified supplies, are to be treated as used for taxable purposes and thus qualify for input tax recovery;
e) the Agreed Method should be construed to mean that sums received by MBNA in respect of accounts which have been designated at any time should be excluded from the turnover fraction;
f) the Commissioners were not entitled to terminate the Agreed Method if the consequence was to impose on MBNA a level of input tax recovery less than that produced by the Agreed Method;
g) if the Commissioners are correct in saying that the Agreed Method did not produce a fair and reasonable attribution of residual input tax by reason of the exclusion of the amounts set out in paragraph 3(b) of the Agreed Method, then that method (construed as applied in the voluntary disclosure) plus the amounts set out in the said paragraph 3(b) and plus the values of sales of such amounts to CCSE should be held to be the correct expression of the extent to which MBNA used, and continues to use, residual inputs;
h) alternatively, use of one or other of various methods (referred to later in our decision) is fair and reasonable;
i) under no circumstances is the current position under which MBNA recovers but 1 per cent of its residual input tax on UK supplies fair and reasonable; and
j) MBNA's claim for input tax for May and June 2000, made on 31 July 2003, is not "capped" under regulation 29 of the Regulations, but rather is to be dealt with under the adjustment provisions of regulation 35 of the Regulations.
- In contrast, the Commissioners maintain that the Agreed Method was validly withdrawn because it wrongly excluded the value of exempt supplies to MBNA's designated cardholders from the denominator of the partial exemption fraction. They contend that, during the four year period the Agreed Method was in operation, its correct interpretation and operation were as originally applied by MBNA, and not as applied subsequently in the voluntary disclosure. They are satisfied that since 1 July 2003, when MBNA was required to recover residual input tax in accordance with regulations 101 and 103, it has correctly applied regulation 101. But in relation to regulation 103, the Commissioners maintain that MBNA is wrong to contend that its correct application involves:
i) excluding the value of its exempt supplies to designated cardholders from the denominator of the fraction; and
ii) including the value of servicer fees in the fraction.
The Commissioners so claim because:
a) supplies of credit to designated cardholders are an exempt supply by MBNA which uses residual inputs to the same extent to the same extent as in relation to supplies of credit to non-designated cardholders;
b) the relative size of the servicer fee is not a reliable indicator of the relative use of residual inputs in servicing; and
c) if MBNA does make supplies by assigning receivables, then those supplies and its supplies of servicing are made in the UK, viz. to a fixed establishment of CCSE at MBNA's UK headquarters in Chester.
- Further, the Commissioners submit that MBNA is wrong to contend, in the alternative, that the correct application of regulation 103 involves including the outstanding face amount of existing receivables and future finance charge receivables in the fraction both because assignments of receivables are not a supply but also, if they are a supply, because they are made in the UK.
- Finally, the Commissioners maintain that MBNA's claim for input tax in respect of the periods April and May 2000 is capped by regulation 29 of the Regulations, not having been made timeously, and regulation 35 is irrelevant in this context.
The Four Appeals
- The case involves four appeals in all. The first is against a decision contained in a letter of 30 June 2003 whereby the Commissioners withdrew the Agreed Method with effect from 1 July 2003 on the basis that it was flawed in wrongly excluding the value of supplies to securitised cardholders from the denominator of the recovery fraction. The second is a decision contained in a letter of 27 November 2003 to inhibit the processing of net repayment claims contained in MBNA's returns for July, August and September 2003. (In practical terms that decision and the appeal relating to it have been overtaken by the Commissioners' decision subsequently to assess MBNA to the tax in question – see the assessments notified on 2 June 2005 referred to below). The third decision under appeal is again contained in a letter, on this occasion dated 3 December 2003, in which the Commissioners rejected the voluntary disclosure of 31 July 2003. The fourth decision, notified on 2 June 2005, consisted of 18 assessments to tax totalling some £3.3 million covering the periods July 2003 to December 2004 inclusive. The Commissioners made those assessments having concluded that MBNA's true level of entitlement to input tax recovery did not extinguish its liability to output tax.
The Questions Before the Tribunal
- We did invite the parties to agree the questions to be answered but they failed to do so. Consequently, it has been left to us to identify them. We trust we have done so, and, allocated to their relevant subject matter, believe them to be as follows:
(1) Withdrawal of the Agreed Method
(a) Was the Agreed Method validly withdrawn?
(b) Should exempt interest and finance charges on designated accounts go into the partial exemption fraction?
(c) Are MBNA's assignments of receivables supplies for VAT purposes so that they should not be included in the partial exemption fraction?
(d) Assuming such assignments are supplies, are they and MBNA's further supplies of servicing them to CCSE made outside the European Union, or to a fixed establishment of CCSE in the United Kingdom?
(2) The Assessments
(a) Has MBNA discharged the burden of showing that less tax is due from it than that assessed, and showing what the amount of tax properly due from or repayable to it is?
(b) Does the servicing of customers' accounts use residual inputs?
(c) Assuming that it does, should that be reflected in the partial exemption fraction using the full servicer fees payable under the servicer agreement or some lesser proportion?
(d) How should the servicer agreement be construed as to its scope, and the administering and collecting of receivables within the meaning of clause 9.1 thereof?
(e) When used as a proxy, does the servicer fee suffer from the further flaw of being unreliable, not being an arm's length value?
(3) The Voluntary Disclosure
(a) What is the correct construction of the phrase "at that particular time" at paragraph 3(b) of the Agreed Method?
(b) Is the voluntary disclosure out of time by reason of regulation 29(1A) of the Regulations in respect of the periods April and May 2000?
Questions (1)(c) and (1)(d) also arose in the recently decided case of Capital One Bank (Europe) plc v The Commissioners (2005) Decision No 19238 ("COBE"), and our answers to them necessarily involve our considering that decision.
General matters
- MBNA was represented by Roderick Cordara QC, leading Mark Smith, and the Commissioners by Nicholas Paines QC, leading Peter Mantle. Oral evidence was given to us by Kevin Ingram, a partner in the firm of Clifford Chance, solicitors, London, who was responsible for preparing the various contracts and other documents effecting securitisations, which we are required to consider to reach our decision, Shane Hollywood, a Jersey advocate, whose firm, Bedell Cristin, was involved in the securitisation contracts, and David Hill, a member of MBNA's staff responsible for VAT matters. We accept the evidence of Mr Ingram in part as an expert in the subject of securitisations. We were also provided with 15 bundles of copy documents, which included the lengthy contracts effecting the securitisations.
- It is common ground that the underlying facts of the securitisations in the instant case are very similar, if not essentially identical mutatis mutandis, to those of the COBE case. Whilst COBE and MBNA are in direct competition in the credit card and personal loans markets, both are advised by accountants PricewaterhouseCoopers and solicitors Clifford Chance, and are represented by the same counsel. Consequently, since securitisation is a very complex subject which had not, prior to the COBE case, been considered by these tribunals and there are large amounts of money at stake, it seems unlikely that either our decision or that in COBE will rest at tribunal level. On that assumption, and with a view to ensuring that any higher court dealing with this or the COBE case has no problem in comparing the facts of the two cases (which might possibly proceed together), we propose to incorporate into our own decision, with only essential amendments, the relevant parts of the COBE decision dealing with the factual aspects of both securitisation in general and its operation in particular. We express our grateful thanks to the COBE tribunal for its meticulous and comprehensive analysis of securitisation. To assist the reader, we provide an appendix to our decision containing the paragraph numbers of our decision and the numbers of those in that of COBE which correspond.
- We then proceed to make our detailed findings of fact.
The Facts
- MBNA is a wholly-owned subsidiary of MBNA America Bank NA which is a wholly-owned subsidiary of MBNA Corporation. It commenced business in the UK in 1993 and has been registered for VAT since 1 April 1994. At all material times, it made monthly VAT returns. It is a "monoline" banker in that it provides only finance to credit card customers and those taking out personal loans. Whilst its core business consists of the making of exempt supplies of credit falling within Group 5 of Schedule 9 to VATA, as we mentioned earlier, it does make some standard-rated supplies e.g. providing canteen facilities. Additionally, as we shall explain in detail later, MBNA makes supplies of servicer services to CCSE, which, as we have also mentioned, is registered and operates in Jersey. It now also makes insurance premium loans and earns (exempt) commission on certain credit insurance transactions.
- MBNA incurred, and continues to incur, input tax on its overheads, such as the costs of acquiring and maintaining telephone and information technology systems, of providing office accommodation, advertising, consultancy services, legal and professional fees, agency staff, printing and plastic card costs, running a call centre and on the general expenses of servicing and administering the credit card accounts. As a partially exempt trader, it was entitled to recover part of that input tax, and agreed with the Commissioners — then the Commissioners of Customs and Excise — that it could use the Agreed Method to recover residual input tax.
MBNA's business
- MBNA is licensed to provide credit and is regulated within the UK by the Financial Services Authority ("FSA"). Its business is run in much the same way as any other credit card business: its customers are issued with cards which entitle them to make purchases, and obtain cash advances, up to an agreed aggregate maximum amount. MBNA is required to finance its customers' purchases by paying to retailers and other suppliers, through the banking system, the cost of the goods or services acquired by the customer, less a charge — a variable percentage of the price — to the merchant known as "interchange", and to make cash available, also through the banking system, to satisfy its customers' demands for advances. Monthly, customers who have any sum outstanding must pay to MBNA an amount between a specified minimum and the total then outstanding. Those who do not pay the full amount are charged interest and MBNA also levies some fees and penalties, for example for late payment by customers of the minimum amount. The interest, fees and penalties (that is, all of MBNA's receipts from its customers, other than of capital) are together known as "finance charges".
- Three characteristics of the credit card business are of relevance in this appeal. The first is the considerable amount of capital which is necessary. The second is the customer's right to make purchases, or obtain cash advances, without notice provided he remains within his agreed credit limit. The third is the fact that, in consequence, the amount of capital which is at any time outstanding (and, correspondingly, the overall sum owed to MBNA by its customers) is variable. Although, as we shall mention later, some predictions can be made with reasonable accuracy and certainty about the behaviour of a large group of people such as the customers of a credit card bank, there are seasonal variations—particularly at Christmas—in the amounts those customers spend, and general economic conditions, wholly outside the issuer's control, may encourage or discourage spending, or increase or diminish the amounts which customers as a group pay in discharge of their outstanding balances each month.
- A credit card company, like any other lending institution, earns its profits from the difference—the "spread"—between the amount it can earn, in the form of the interest and other charges due to it from its customers, and the cost to it of obtaining the funds used to pay for the customers' purchases and cash advances—its working capital. Although there are, we understand, quite wide differences between the amounts credit card companies charge their customers, tempered by special offers and discounts, there is nevertheless intense competition and, in consequence, continual downward pressure on the amounts which can be charged, particularly by way of interest. It is correspondingly in the companies' interests to minimise the cost to them of the funds they use. Credit card companies must, not least for regulatory reasons, have some capital of their own but they are not required to fund the entirety of their operations from their own resources. They may instead (and, in practice, almost all do) borrow some of their working capital.
- While issuers which carry on other types of business in addition may draw on several sources for their capital—for example the UK clearing banks may use the sums kept by customers in their current accounts on which little, if any, interest is paid—"monoline" issuers such as MBNA do not have access to relatively cheap and plentiful funds. Such companies may borrow from their parent companies but that has two disadvantages: the parent may not have sufficient funds of its own and, even if it has, the regulatory authorities in both the UK and the US impose limits on the amounts which may be lent and borrowed in this way. A simple borrowing on the capital markets is comparatively expensive for an institution such as MBNA, which has no credit rating at all of its own and, if it were to borrow, would have to procure its American parent's guarantee of the loan. Even then, the FSA, MBNA's UK regulator, will not permit it to be over-reliant on its parent.
- The credit rating of a financial institution, and of securities issued by such institutions and others (for example quoted companies) is determined by credit rating agencies, of which the best known are Standard and Poor's, Fitch and Moody's. The best possible rating (using Standard and Poor's system) is AAA, signifying that the risk of default is no greater than that on US government bonds. On the same scale, the lowest commercially recognised rating is BBB. Unsurprisingly, the higher an institution's credit rating, the lower the interest rate it must expect to pay on borrowed funds; but an institution cannot (except over a comparatively long time) acquire a higher credit rating because of its track record, and even then there will be material, external, factors which it cannot control itself. In addition, MBNA's credit rating, if it had one, would be adversely affected by its being a monoline business with no opportunity to offset losses from one activity against profits derived from another.
Securitisation
- A possible solution, from the point of view of an issuer such as MBNA, and the focus of certain aspects of this appeal, is securitisation, a capital-raising process which was invented in the United States, and was originally used in the residential mortgage market but has since been adopted by other capital-intensive businesses generating a predictable income stream. We were told that it has been commonly and very extensively used in the UK and in continental Europe for between ten and fifteen years, and those availing themselves of the process now include all the UK clearing banks (except Lloyds TSB), despite their ready access to cheap funds and other large financial institutions. Securitisations will be similar in terms of structure but differ in detail depending on the nature of the assets securitised.
- A credit card issuer, or any other institution wishing to do so (an "originator"), obtains capital by assigning the sums it is due to receive from its customers (i.e. "the receivables") to another legal entity which, directly or indirectly, borrows in the capital markets, using the assigned receivables as security, and paying the amount it borrows to the credit card company. The lender assumes the risk that the originator's customers will fail to pay their debts, but it can measure the risk of that failure against the known historical experience and the substantially predictable behaviour of a large group of people. The risk is assessed by the rating agencies, which give the assigned receivables (or, perhaps more accurately, the negotiable instruments for which they constitute the security) an appropriate rating. In practice the risk of default, beyond an assumed level of which account is taken when receivables are securitised, is very small and, typically, a portfolio of credit card receivables securitised in the manner in issue in this appeal can attract the highest possible credit rating of AAA (again adopting Standard and Poor's rating system), equivalent to that of a US Treasury bill. Indeed, some 88 per cent of the securities issued in connection with MBNA's securitisations usually achieve an AAA rating; of the remainder, five per cent usually achieve an A rating and seven per cent a BBB rating. We might add that MBNA itself does not have a credit rating, its ultimate US parent has a BBB rating. Achieving the highest practicable rating is the most important objective of a securitisation, to which all the others are subordinate. Large parts of the contracts, to which we shall come shortly, are devoted to ensuring that nothing is done which might adversely affect the rating agencies' assessment of the securitised assets. The advantage to the issuer is that, because of the higher rating, the cost to it of obtaining the funds it needs to conduct its business (that is, the interest it must pay) is lower than it would be if it were to borrow directly from the lender (commonly referred to, in the context of securitisations, as the "investor").
- The advantage for the lender is that it is insulated from the much greater risk that the credit card issuer might itself become insolvent for reasons other than the poor performance of its credit card portfolio, a risk to which the lender would be exposed if it were to make a simple loan. Commercial interest rates within the United Kingdom are normally determined by reference to the London Inter-Bank Offer Rate, or LIBOR, being set at small increments above that rate, which can move up and down (though usually only within very small limits) on a daily basis. The difference between the rates of interest charged to AA-rated and BBB-rated borrowers might appear quite small—the range, we understand, may be of as little as a half of a single percentage point—but the difference in cost, taking into account the amount of money borrowed and the period of the borrowing, can be considerable. Thus the benefit to MBNA of securitising its receivables and thereby securing funds at a rate of interest appropriate to an AA-rated borrower rather than that it would be required to pay if it borrowed conventionally in the market significantly outweighs the substantial cost, particularly in professional fees, of the securitisation.
- Although each securitisation differs in detail from every other, we understood that all securitisations, or at least those of the "revolving trust" variety with which we are concerned in this appeal, after some initial experimentation, now follow much the same pattern, although the US and UK models are not identical as differences in the law must be accommodated. The essentially similar structure is used in part because there is nothing to be gained from continually re-inventing a contractual framework which achieves its objective and partly because investors are familiar with the standard framework and are correspondingly reluctant to expend time and money on evaluating the efficacy of other methods; even so, the investors receive reassurance, in respect of each securitisation, in the shape of the credit agency rating which is in part based upon a detailed letter giving various warranties written by the solicitors who have prepared the documentation. An important feature of the letter is that it identifies the manner in which the securitised assets are insulated from any liability, or risk of insolvency, of the originating institution.
- It was agreed that the contracts with which we are concerned are entirely consistent with current market standards. MBNA's 1995 securitisation was the first established in the UK market, but is now somewhat old in form. Nevertheless, its basic structure was followed in the 2001 securitisation.
- The arrangements must, if they are to be effective, satisfy a number of requirements of regulatory agencies and accounting bodies, which do not always coincide; the solution to one problem might give rise to another. Some, such as the isolation of the lender from the risk of the credit card issuer's insolvency which we have already mentioned, are dictated by market requirements but are also imposed by the regulatory authorities. In particular, the FSA and other regulatory bodies, we were told, do not consider it appropriate that the credit card issuer should, even indirectly, underwrite the ultimate repayment of the borrowing (from which, if MBNA's arguments are correct, it has distanced itself) and the contracts expressly exclude any such underwriting. On the other hand, the issuer has an interest in seeing that the investors are repaid since otherwise it would encounter difficulty in undertaking a further securitisation in the future. The FSA's objection extends, however, to support which, even though not a contractual obligation, is in fact given by the issuer if there is any risk that the loan will not be paid. There are also tax considerations to be borne in mind since the securitisation might generate a tax liability which (we infer) would not arise were the credit card issuer to raise money in another way, and Mr Ingram and his colleagues have spent a significant amount of time obtaining Inland Revenue clearances for this and other securitisations in which they have been involved. (We should perhaps add that there is no suggestion by the Commissioners that securitisation is a tax-avoidance device). MBNA's 2001 securitisation structure was designed not to create any form of agreement for sale in the form of a stampable document.
- In other respects there is a conflict, or potential conflict, between regulatory and market requirements. Although the US and UK regulatory authorities have the same, or at least closely similar, objectives (and some European Union directives are also in point), they endeavour to achieve them in different ways. American and United Kingdom accounting standards, too, differ in some ways.
- The detail of various requirements which influenced the structure of the securitisations are, with three exceptions, of peripheral relevance to the issues we must decide. As MBNA has an American parent, its securitisation structure has to meet the requirements of the US regulatory agencies and accounting bodies.
- Two of the exceptions are the consequence of US requirements. The first, which MBNA contends is reflected in substance and in form in the structure which has been achieved, is that the assignment must be a true sale. MBNA contends that there are five reasons why sales of receivables have to be true sales, namely:
i) a sale means that the receivables will not form part of MBNA's estate in the event of its becoming insolvent;
ii) the US accounting bodies' isolation criteria in FAS 140 require a true sale for the assets to be outside the control of MBNA. (FAS 140 has a control-based test for off balance sheet treatment, whereas the UK equivalent, FRS5, has a risk and rewards based test);
iii) there is no need to register any security interest because, by definition, there has been a sale. (Security over a shifting pool of assets is understood to be risky as possibly being ineffective – or it might be held to be a floating security, and thus be less effective);
iv) the FSA does not allow a bank to grant floating charges because a consequence thereof might be an administrative receiver seeking to take over its assets; and
v) if a securitisation were structured as a loan against security rather than as a true sale, the grant of security might put a bank in breach of covenants with third parties not to grant security.
No one other than the Commissioners has suggested that MBNA's securitisations are not true sales.
- The second exception is that the SPVs which are used for the implementation of the securitisation must not, by US regulatory rules, be allowed any discretion. The evidence did not extend to a full explanation of the reasons behind those requirements (though it was apparent that the latter is in part designed to ensure that the operation of the arrangements cannot be upset), but what Mr Ingram told us was undisputed and we accept that the requirements were significant factors affecting the structure of the arrangements. The third requirement of significance, on which Mr Ingram laid considerable emphasis, is that the risk of cardholder default must be transferred from the originator to, ultimately, the investors. That requirement is not specifically US-driven. We shall return to the significance of these three points.
- An important practical consideration lies in the nature of credit card debts: those in existence at the moment of securitisation ("existing receivables") are paid off, frequently within a short period (many customers pay off the entirety of their debts each month – such customers are called "transactors") and other debts ("future receivables") come into existence as the same customers make further purchases or take cash advances. The credit card company does not set out to accelerate its cash flow by selling debts, crystallised at the moment of sale, and which will be paid in the fairly near future, but to secure working capital which it may use for the purposes of its business over a reasonable period, an objective which it could not achieve by assigning finite debts in return for a single payment, in the same way as debts may be factored. Similarly, the ultimate investors do not wish to buy debts at a discount, and to recover the amount advanced within a short period, but to make a medium-term loan on which they can earn interest, while remaining confident that the capital sum advanced will be repaid at the agreed time.
- A securitisation must take those objectives into account and contain a mechanism to accommodate the fact that debts are paid off by the customers, and replaced by new debts; thus the security is constantly shifting. During the period when the capital is intended to remain outstanding (the "revolving period") sufficient money must be released from the customers' payments to pay the interest and to meet the administrative cost of servicing the customers' accounts and the securitisation itself. What remains is available to the credit card company, which can use the capital element as working capital; the income element is treated as profit. There must also be a means by which, at the end of the term, the capital sum is repaid; this occurs not immediately, but over a time known as the "amortisation period". In some types of securitisation the length of the revolving period is fixed, and can typically extend to about five years, but in others, the initial term is shorter (again, for regulatory reasons which it is not necessary to develop).
- Because of the requirements of the regulatory authorities, accounting standards and the rating agencies, the securitisation of credit card receivables (and, we deduce, other similar assets) requires several participants and a substantial number of contracts. Those with which we are concerned were prepared by a team led by Mr Ingram.
The Contracts
- MBNA commenced securitisations in 1995. Initially they occurred under its "UK Receivables Trust I" structure. In 2001 the "UK Receivables Trust II" was put in place. A number of securitisations have taken place under each of the two structures. Under the "Trust I" structure there were 12 transactions in its first six years, and under the "Trust II" structure, securitisations totalled £3 billion by 2003. The "Trust I" and "Trust II" structures are broadly similar, the main difference between the two being that the latter reflects developments in securitisation procedures which have occurred since the former was established.
- The contracts used for MBNA's securitisation were all made by deed (which we understand is invariably the case), and all, including those affecting the Jersey-registered vehicles, are expressed to be governed by English law. Those of the "Trust II" series, that being the one by the reference to which evidence was essentially adduced (although the "Trust I" series remains open), were made on 26 September 2001 and amended and re-stated on 26 October 2001. Each contract was made between different parties (though MBNA itself was a party to most of them) and had a limited function. Together, however, they created a framework within which each of MBNA's individual securitisations could be effected, but they did no more than provide the framework. The details of each securitisation vary, and they are recorded in and effected by a supplement which relates only to that securitisation. The framework can, and does, support multiple securitisations, of the same and different types. Those with which we are concerned are of the same type.
- The deeds cater for various contingencies, many of which are not material here and which we can ignore. They are long and extremely complicated; it is almost impossible to follow them by reading the clauses in numerical order and by reading them one after another; indeed, one of the key deeds is comprehensible only when read with its supplement, which adds clauses without which it is impossible to follow or understand the flows of money which occur. Among them there is a Master Framework Agreement, whose sole purpose is to provide definitions of the terms common to the various deeds; some other terms, used in a single deed, are defined only in that deed. We have simplified the following analysis as much as we think it is possible to do without omitting any feature which is germane to the parties' arguments and to our conclusions and we have focused on only two deeds and the two relevant supplements; even so, it will be apparent that the detail and complexity of the arrangements is formidable.
- Although the deeds all bear the same dates, logically the first, since it sets the process in motion, is the Receivables Securitisation Deed. In that of 26 September 2001 there are two parties: MBNA as both "Seller and Offeror" and as "Transferor and Offeror", and CCSE. (The Receivables Trustee for MBNA's first series of securitisations was CCSI which was also incorporated in Jersey). CCSE, like the other Jersey companies to which we shall refer later, is an SPV, and was established solely in order that it might play its part in the securitisations intended to be effected in accordance with the deed; it has no other purpose or function, and cannot participate in any securitisations other than those effected in accordance with this deed. Its issued share capital is beneficially owned by a Jersey general charitable trust, a device designed to prevent its being owned, or treated as if it were owned, by MBNA or any of the other organisations involved in the securitisation, or treated as if it were in MBNA's corporate group. Its directors at the relevant time were a Mr Gerwat, a Mr Richardson and a Mr Akin, who are domiciled and resident in Jersey, and they carry out their duties as directors there. We shall deal with the nature of the trust of which CCSE acted as trustee shortly. Structures making extensive use of trusts are usual in the UK but not in US and continental European securitisations since their legal systems provide a different mechanism, but we understand that the essential characteristics of US and continental schemes are much the same.
- The Receivables Securitisation Deed grants MBNA the right to initiate "from time to time" what is described as a "possible securitisation" by first nominating any one or more of its customers' accounts, and then offering to assign the receivables, existing and future, arising on the accounts so nominated (but not the accounts themselves) to CCSE. MBNA is not allowed to nominate an ineligible account—that is, one where the customer is not an individual, has already defaulted, or is not resident in the United Kingdom, or which fails to satisfy some other formal requirements—and in practice it nominates very large numbers of accounts simultaneously. For regulatory reasons, nomination has to be undertaken on a random basis; this requirement is designed to prevent a credit card bank from securitising only the better quality accounts, thus giving the ultimate investors an advantage, and to eliminate the possibility that the bank will expose itself to excessive risk as a result of its being left with the less desirable accounts. Nomination requires no more than the identification by MBNA of the relevant accounts in its records. In practice this is done by its computer attaching a marker to each nominated account. Provided it respects the requirement that its nomination be random, MBNA can, and does, determine the aggregate value of the accounts which it nominates at any one time.
- What MBNA may validly offer to assign is strictly defined. It cannot be selective; with some limited—and automatic—exceptions, to which we will return, once accounts have been nominated for the purpose of a securitisation the receivables attaching to them must be included in any offer made for the purpose of that securitisation. Moreover, it is necessary to offer to assign the entire benefit of each nominated account included in the offer, which benefit is allocated to six distinct categories, a division which reflects the intricacy of the arrangements. The six categories are:
(1) "Existing Receivables", that is the amount owed to MBNA by the customer at the time the offer is accepted;
(2) "Future Receivables which are not Finance Charge Receivables", being principal (in respect of purchases and cash advances) for which the customer will (it is assumed) incur a liability to MBNA in the future;
(3) "Future Receivables which are Finance Charge Receivables", that is future charges of interest, fees and penalties to be levied by MBNA against the customer;
(4) the benefit of guarantees and insurance policies (for example policies protecting a customer against the risk that he might become unable to discharge his debt by reason of redundancy);
(5) "Acquired Interchange", representing the charge levied by MBNA on retailers and other suppliers accepting its card in payment for goods and services: this is a calculated amount, but it is not assessed on an account-by-account basis; and
(6) "Acquired Recoveries", being an amount equal to the outstanding face amount of the Principal Receivables.
The last three of those categories are of no immediate relevance, and we propose to ignore them for the purposes of this decision.
- An offer must be made in the form set out in a schedule to the deed. A valid offer may be made only if some formal conditions, relating to MBNA's solvency, are satisfied. CCSE cannot choose whether or not to accept an offer; it has no discretion in the matter. It is a requirement of the US regulatory authorities (though not those of the UK) that "Qualifying Special Purpose Entities", of which CCSE is one, must have no discretionary powers. The approach adopted in the agreements is that CCSE delegates its nominal discretion, in this and in any other context in which it is required to make a decision (in effect, to implement MBNA's own decision), to the Brussels branch of the Deutsche International Trust Corporation (CI) Limited ("Deutsche"), an organisation at arm's length to MBNA and to CCSE. Deutsche, too, has only a notional discretion; provided the objective criteria are satisfied it must instruct CCSE to accept any offer MBNA makes, and CCSE must follow the instruction. There is no facility for negotiation, and the deeds are silent about the consequences of a failure to accept an offer; there is an evident assumption that every offer made will be in due form and therefore accepted. The delegation is reflected in the wording of the Receivables Securitisation Deed, but is implemented by a separate RT [Receivables Trust] Operating Agreement, made between CCSE and Deutsche, which is described in the deeds as the "RT Operating Party". There is an undertaking by CCSE with MBNA, in the Receivables Securitisation Deed, that it will comply with Deutsche's instructions.
- The offer is of an assignment of receivables; the value of the receivables to be assigned, and the amount which MBNA expects to receive in return, are not specified in the offer itself. It does state, however, that it may be accepted, once the face value of the Existing Receivables included in it has been notified by MBNA to CCSE, by the payment by CCSE to MBNA of an "Acceptance Price" of £10,000. Although the prescribed form of the offer itself does not say so, the contracts provide that the Acceptance Price is to be followed immediately by a "Further Payment". The Further Payment is defined as the "Outstanding Face Amount of the Existing Receivables … less the Acceptance Price". There will, of course, be a change in the value of the Existing Receivables between the date of the offer and the date of acceptance, since there are daily movements on customers' accounts, and the deed provides for calculation and notification of the precise amount on the day on which an offer is to be accepted. The two-stage payment process is not a factor material to our decision; it was designed primarily to avoid the imposition of stamp duty by reference to the value of the Further Payment (the stamp duty rules have since been changed, making this complication no longer necessary). Since CCSE, through Deutsche, is required to accept any offer which complies with the deed's conditions, MBNA is effectively able to dictate the amount it receives, by nominating accounts with an aggregate value of Existing Receivables of the chosen sum. In practice, it nominates accounts whose Existing Receivables have, or are expected to have, a face value significantly higher than the amount it wishes to receive in cash. This is done in order to ensure that there will at all times be sufficient receivables to provide security for the amount raised, allowing for the fluctuations which will occur as customers pay off their debts and create new debts, and to provide a margin for the predictable level of customer default (that is, complete failure to pay the amount due rather than delay in payment, a topic with which we do not need to deal further). We shall explain how the structure accommodates the surplus shortly.
- The contracts provide that, when an offer has been accepted, additional payments become due as time passes: "an amount equal to the Outstanding Face Amount of the Principal Receivables (a sum which, so far as we have been able to ascertain, is not given a name of its own); and "Deferred Consideration", to the meaning of which we shall return in due course. The aggregate of the four payments (Acceptance Price, Further Payment, amount equal to the outstanding tax amount of the Principal Receivables and Deferred Consideration) is defined as the "Purchase Price".
- MBNA's offer, once accepted, is to assign the Existing Receivables, immediately, and the Future Receivables as they come into existence. The assignment is to take effect in equity only, although there are provisions which come into effect in certain eventualities (in essence, if MBNA becomes insolvent) one of which allows CCSE to give notice of the assignment to the debtor-customer (in the contracts called an "Obligor"), thus converting it into a legal assignment. In practice, no such notice has ever been given (and the affected customers remain entirely ignorant of the assignments affecting their accounts) but the possibility of giving notice remains in case it should become necessary for CCSE to enforce the debt and MBNA is unable or unwilling to join in an action to do so. Upon acceptance of an offer, the nominated accounts become "Designated Accounts".
- CCSE acts only as the trustee of a trust of which there are now four beneficiaries: Deva One Limited, Deva Two Limited, Deva Three Limited and MBNA itself. Deva One Limited, Deva Two Limited and Deva Three Limited are Jersey-registered SPVs whose only role, like CCSE's, is to participate in the securitisation, and they are collectively described in the documentation as the "Investor Beneficiaries". Mr Gerwat and Mr Richardson are their only directors and their beneficial ownership, too, lies in the same Jersey charitable trust as owns CCSE. Their task is to issue the loan notes which, as we shall later explain, are, or are the evidence of, the ultimate investors' security; none does anything else and, like CCSE and for the same reasons, none is permitted any true discretion. Although the arrangements contemplate three varieties of loan notes, we are concerned with only one, Commercial Paper Loan Notes which were issued by Deva One Limited. (In the relevant period, Deva Two Limited was inactive, having been formed to deal with a type of loan notes not yet issued. Deva Three Limited was added later; it too has been inactive.)
- The trust is known as the "Receivables Trust". The manner in which the trust property is to be held by CCSE is dictated by the second of the principal deeds, a Receivables Trust Deed and Servicing Agreement UK Receivables Trust II ("RTDSA"), the deed which also controls the day to day administration of the securitisation, a topic with which we shall need to deal in some detail. It was made on 26 September 2001, and amended and re-registered on 26 October 2001, between CCSE, as the Receivables Trustee, MBNA, variously described as the "Transferor Beneficiary", "Servicer", and "Transferor", Deva One Limited, Deva Two Limited and, now, Deva Three Limited.
- The documentation makes it clear that the trust is a bare trust, and that CCSE again has no discretionary powers: it must deal with the trust property in the exact manner dictated by the deeds. This feature of the arrangements is of particular relevance to one of the issues which we must decide, and we will return to it in due course. At this stage we need do no more than record that the administration of the trust is undertaken in accordance with an agreement specific to this securitisation by Bedell Cristin Trust Company Limited ("BCTC"), a company owned and controlled by Bedell Cristin, the Jersey law firm of which Mr Gerwat and Mr Richardson are partners. Mr Hollywood's evidence was that although the administration has to be carried out in a manner which respects the strict requirements of the deeds it is not a purely mechanical process, since it is necessary for the directors to ensure that the formal requirements have been satisfied, and that what is required of the companies is lawful. BCTC's business consists of the provision to companies of fiduciary and administrative services, including but not limited to those required in securitisations, and that it is licensed to provide such services by the regulatory authorities in Jersey.
- We should perhaps also mention that one consequence of its being a bare trust is that the beneficiaries for the time being could, if they chose, terminate the trust and demand that their respective shares of the assets be transferred to them, and that CCSE would have no means by which it might prevent them from doing so. MBNA is, for all practical purposes, able to control Deva One Limited (and for that matter Deva Two Limited and Deva Three Limited) and could force it to join it in making such a demand. In practice, the possibility of its doing so is little more than theoretical, since the Investor Beneficiaries' interests are the security for loan notes they have issued but, as we shall explain, the fact that the power exists, but its exercise is so restrained, is in our view a material factor.
- The deed provides that CCSE is to hold the trust property "for the purpose of receiving amounts arising therefrom [that is, coming into the trust] and transferring and distributing such amounts in accordance with" the RTDSA. In order to make those functions possible, the trust has five divisions which (somewhat simplified) are as follows:
(1) the "Undivided Bare Trust", encompassing all trust property other than that allocated to another division, which is to be held on an undivided basis for the benefit of each of the beneficiaries for the time being of the trust;
(2) the "Ineligibles Bare Trust", comprising Ineligible Receivables and Ineligible Collections—items which have mistakenly been included in the securitisation despite the ineligibility of the underlying accounts and which must be returned to MBNA; this property is to be held on a "segregated separate trust for the absolute benefit of" MBNA alone;
(3) the "Segregated Bare Trusts", comprising that trust property which CCSE has "expressly segregated … for the benefit of an Investor Beneficiary or [MBNA]"—this category cannot include property which falls within categories (2) or (4);
(4) the "Deferred Payment Bare Trust", which applies to the "Additional funds … received by CCSE pursuant to the terms of any Supplement"—the property within it is to be held on a "segregated bare trust for the purpose of paying Deferred Consideration to MBNA"; and
(5) "Other Trusts", covering property expressly segregated by CCSE for the benefit of any beneficiary other than MBNA, according to the terms of a Supplement; this trust allows for the possibility that further Investor Beneficiaries will be created.
- Although the Receivables Securitisation Deed describes what it envisages rather tentatively as a "possible securitisation" the process is, of course, organised carefully in advance, and all of the necessary steps are so arranged that they occur in the correct sequence, and at the appropriate times. CCSE has no assets of its own, apart from the nominal £2 which each of the beneficiaries paid in for the purpose of creating a fund to which the trust could immediately attach, and it cannot pay the Acceptance Price or the Further Payment unless steps have already been taken to secure the necessary funds. Those funds are raised through the medium of loan notes issued, as is appropriate to the type of securitisation then intended, by Deva One Limited, Deva Two Limited or Deva Three Limited. The security for the loan notes is the issuer's beneficial interest in the trust assets, represented by the receivables allocated to a segregated bare trust within category (3) above.
- The loan notes, in common with all others contemplated by the deeds, are non-negotiable, because the intention is not that the loan-note holders—the financial institutions to which they are issued—will themselves provide the funds representing their face value, but that they will in turn issue negotiable securities to be acquired by the ultimate investors, and which can be traded freely in an appropriate market. The negotiable securities issued in a revolving securitisation are known as "commercial paper". The institutions which act as loan note holders are also known as "conduits" because they act as the link between the borrower and the true lenders, channelling the amount raised from the lenders to the trust at the outset, the interest during the currency of the loan and the repayments of capital as the loans are discharged. It is undesirable that the loan notes should be assignable as it is necessary for the working of the scheme that the holders can be relied upon to co-operate in the arrangements; moreover, the identity of the loan-note holders is itself a factor which might affect the credit rating of the commercial paper. It is, ultimately, the rate of interest payable on the commercial paper, lower than that at which MBNA could itself have borrowed in the market, which leads to the saving we have described, the driving force behind the scheme.
- While the financial institutions which hold the loan notes and issue the commercial paper know of the arrangements in accordance with which the security has been created (as do the rating agencies), the holders for the time being of the commercial paper (the "investors") usually know no more than that the ultimate security for it consists of credit card receivables. They rely on the rating agencies' assessment of that security and, unless they guess correctly, do not know of MBNA's participation.
- From the customer's point of view, nothing changes when his account becomes the subject of a securitisation. As we have said, although the deeds provide for the giving of notice to the customers, this is a contingency provision and in practice the customers do not receive notice of the assignment, and indeed nothing at all is said to them. Their agreements with MBNA are unaffected; as the recitals to the RTDSA put it, MBNA "will continue to have contractual relationships with the Obligors on the terms set out in the Lending Agreements [MBNA's standard-form agreements with its customers] and accordingly will continue to be a grantor of credit in respect of both Existing Receivables and Future Receivables". The customers continue to receive monthly statements and other communications from MBNA, which renews their cards whenever necessary, provides the funds to finance their purchases and cash advances, and collects their payments. The majority of MBNA's UK staff, too, do not know whether an individual customer's account has been the subject of a securitisation; only those with access to the relevant part of the computer record are able to distinguish between those accounts which have, and those which have not, become Designated Accounts. Thus a customer who, for example, telephones with an enquiry is treated by MBNA's staff in exactly the same way, whatever the status of his account.
- Behind the scenes, however, it is necessary to have arrangements in place for the servicing of the accounts and, in particular, the handling of customers' payments to MBNA. All of those arrangements are provided for by the RTDSA, although some of the detail is dealt with in supplementary documents. In theory, the customers' accounts could be serviced by an independent organisation, or by CCSE itself if it had the necessary resources (and the agreements make provision for the appointment of Deutsche as the servicing organisation, though only as a contingency measure), but for practical reasons, as the arrangements envisage, it is necessary for MBNA to continue dealing with its customers as hitherto. Despite the contingency provisions catering for the possibility that MBNA will become unable to continue the servicing, all of the documentation assumes that, unforeseen circumstances aside, MBNA will continue to service the accounts after the assignment. Its doing so is, indeed, a factor in the rating agencies' assessment of the creditworthiness of the assigned receivables, since MBNA, but not CCSE nor, we deduce, Deutsche, has the resources to service the accounts, and experience of doing so.
- The provisions for payment to MBNA for servicing the designated accounts are to be found in paragraphs 9.1 and 9.2 of Part 4 of the RTDSA, and are in the following terms:
"PART 4 APPOINTMENT AND DUTIES OF SERVICER
9. SERVICER FUNCTIONS
9.1 Acknowledgement, Acceptance of Appointment and Other Matters Relating to the Servicer
(a) The Receivables Trustee hereby appoints MBNA Europe and MBNA Europe agrees to act as the Servicer for the Receivables Trustee under this Deed. By its execution of a Supplement each Beneficiary consents to MBNA Europe acting as Servicer. For the avoidance of doubt, it is understood and acknowledged that the obligations of the Servicer herein described are obligations undertaken only in favour of the Receivables Trustee.
(b) The Servicer shall service and administer the Receivables and shall collect payments due in respect of the Receivables in accordance with its customary and usual servicing procedures for servicing credit card receivables comparable to the Receivables and in accordance with the Credit Card Guidelines and shall have full power and authority, acting alone or through any party properly designated by it hereunder, to do any and, all things in connection with such servicing and administration which it may deem necessary or desirable. The Servicer shall follow such instructions in regard to the exercise of its power and authority as the Receivables Trustee may from time to time direct Provided that nothing herein shall be taken to constitute the Servicer as an agent of the Receivables Trustee.
9.2 Servicing Compensation
(a) As full compensation for its servicing duties and activities as provided for in Clause 9.1 and as reimbursement for any expense incurred by it in connection therewith, the Servicer shall be entitled to receive from the Receivables Trustee (solely to the extent of payments received from the Beneficiaries and utilising Trust Property for that purpose as provided in this Deed and in any Supplement) a servicing fee (the "Servicing Fee") with respect to each Monthly Period payable monthly on the related Transfer Date, In an amount calculated (subject as provided in Clause 9.2(c)) as being equal to one-twelfth of the sum of:
(i) the product of:
(1) the weighted average of the Series Servicing Fee Percentages specified in each Supplement in respect of an Outstanding Series, in each case weighted by the proportion that the Investor interest of such Series bears to the Combined Aggregate Investor Interest as of the last day of the relevant Monthly Period (or, if MBNA Europe is Servicer, such other percentage as shall be agreed by the Servicer and the Receivables Trustee (with the prior written consent of each of the Beneficiaries) Provided that each Rating Agency has confirmed in writing that such proposed percentage will not result in a downgrade or withdrawal of its then current rating of any outstanding Associated Debt; and
(2) the average daily aggregate Outstanding Face Amount of Principal Receivables comprised in the Trust Property during such Monthly Period; and
(ii) Any additional amount agreed from time to time between the Receivables 'trustee and the Servicer.
(b) An amount equal to the portion of the Servicing Fee payable by the Receivables Trustee to the Servicer in respect of which the Receivables Trustee is to be reimbursed from payments made by the Investor Beneficiaries in respect of a particular Series with respect to each Monthly Period (the "Investor Servicing Fee Amount` with respect to such Series) will be determined In accordance with the relevant Supplement. The Investor Beneficiaries will pay the Investor Servicing Fee Amount to the Receivables Trustee, in respect of such Series by way of Additional Funds for the grant of the relevant Investor Interest.
(c) An amount equal to the portion of the Servicing Fee (with respect to any Monthly Period) for which the Receivables Trustee is not to be reimbursed from payments made by the Investor Beneficiaries in respect of each Series, respectively, pursuant to any related Supplement (the "Transferor Servicing Fee Amount") shall be paid to the Receivables Trustee by the Transferor Beneficiary from the Transferor Finance Charge Amount and Transferor Acquired Interchange Amount or other Trust Property allocable to the Transferor Beneficiary (or from any other property of the Transferor Beneficiary which may be available for such purpose) on the related Transfer Date. In no event shall any Enhancement Provider or the Investor Beneficiaries be liable to reimburse the Receivables Trustee for the share of the Servicing Fee with respect to any Monthly Period in aspect of which the Receivables Trustee is to be reimbursed from payments to be made by the Transferor Beneficiary, provided, however, that the amount of Transferor Servicing Fee Amount for any Monthly Period shall not exceed the aggregate amount of the Transferor Finance Charge Amount and Transferor Acquired Interchange Amount for such Monthly Period. The Transferor Beneficiary will pay the Transferor Servicing Fee Amount as part of the consideration for the grant of the Transferor Interest.
(d) It is a condition of the UK Receivables Trust It that each Beneficiary of the UK Receivables Trust Il undertakes, when it becomes a Beneficiary, to the Receivables Trustee for the benefit of itself and as trustee for each other Beneficiary that it will reimburse the Receivables Trustee for the share of the Servicing Fee (including the Success Servicing Fee) payable by the Receivables Trustee to the Servicer pursuant to Clause 9.2(a) and Clause 9.2(f) which is to be met by the Receivables Trustee from payments to be made by such Beneficiary to the Receivables Trustee as distributed and specified in such Supplement, Provided that if the Receivables Trustee MW the Servicer shall agree on any change in the amount or method of calculation of any Servicing Fees (in accordance with Clause 9.2(a) or otherwise) or Success Servicing Fees (in accordance with the tests of the relevant Supplement or otherwise), there shall be no related increase in the amount for which any Beneficiary is obliged to reimburse the Receivables Trustee under this Clause 9.2 except if and to the extent that
(i) the Beneficiary concerned shall first have agreed the said increase in writing with the Receivables Trustee; and
(ii) all of the Beneficiaries concerned shall have obtained an Opinion of Counsel that any agreement on their part as mentioned in (i) above will not prejudice the Tax treatment of the UK Receivables Trust 11 or the Beneficiaries.
In the event that MBNA is the Servicer, it may from time to time, with the consent of the Receivables Trustee, elect to receive a reduced or increased Servicing Fee, provided that the aggregate amount payable by way of Servicing Fees shall not exceed the amount that would have been payable if there had been no change in any of the Series Servicing Fee Percentages that were specified in each Supplement at the time when each Supplement was executed. Where EBL makes an election under this Clause 9.2(e), it shall do so, in its capacity as Servicer, by notice in writing to the Receivables Trustee setting out proposals regarding any necessary consequential changes to the relevant Supplements for any then Outstanding Series.
(f) As compensation for successful performance of its servicing activities in respect of Trust Property, the Servicer shall be entitled to receive from the Receivables Trustee (solely to the extent that the Receivables Trustee is reimbursed from payments made, by the Investor Beneficiaries with respect to each Monthly Period) a success servicing fee (the "Success Servicing Fee") with respect to each Monthly Period, payable monthly on the related Transfer Date in accordance with the relevant Supplements for any then Outstanding Series. For the avoidance of doubt, the Success Servicing Fee is included in and forms part of the Servicing Fee referred to in Clause 9.2(1) above."
- The servicing arrangements provided for by the RTDSA can conveniently be divided into two categories: those relating to the day-to-day handling of receipts from customers, and accounting for them; and those relating to the periodic allocation of the funds. The arrangements in the revolving period, when no repayments of principal are made to the investors, differ from those in the amortisation period, when such repayments must be made. We concentrate on the revolving period, though some description of the amortisation process is necessary.
- Because there is no overt distinction between those customers whose accounts have become designated and those whose accounts have not (nor between accounts which have been designated for different securitisations) all receipts from customers (which are called "Collections") are initially paid into MBNA's general purpose Operating Account. Thereafter the money attributable to Designated Accounts (and so identified by MBNA's computer) is to be paid, within two business days, into CCSE's "Trustee Collection Account". In practice, a computer programme run by an MBNA company in the USA segregates its receipts correctly. Its first task is to separate receipts from customers with Designated Accounts from its other receipts (we ignore for present purposes the additional complication which results from there being two or more concurrent securitisations). The latter may be dealt with by MBNA as it pleases, but the former must be further allocated to six categories, as the RTDSA identifies them. The money itself is not divided at this stage, but is transferred as a single sum to the Trustee Collection Account. At the same time MBNA's computer generates a daily report setting out the sums included in the total amount transferred which belong to the various categories, which is sent to CCSE. The report amounts to a set of instructions to CCSE, requiring it to apply the aggregate sum received each day in specified ways. CCSE has no facilities of its own by which it might undertake the task of identification, or which might enable it even to verify what MBNA has done, and it merely follows the instructions set out on the daily report. The deeds provide for the establishment by CCSE of a series of bank accounts, in order that the receipts may be held separately and payments may be charged against the appropriate source. CCSE makes inter-account transfers daily, with monthly adjustments. The monthly adjustments are made in accordance with another set of instructions which is generated (drawing on data provided by MBNA) by a computer owned by MBNA.
- The first and most important of the required segregations is between Principal Collections—repayments by customers of principal sums advanced to them, and the cost of their purchases—and other items, of an income character. The former are, broadly speaking, repaid to MBNA daily. Principal Collections may be drawn upon to make up any shortfall in the sums due to the investors, should that be necessary, before any payment to MBNA is made, but a shortfall on one day may be compensated for by a surplus on another and, over time and assuming no unforeseen loss, all of the Principal Collections are returned to MBNA during the revolving period. The total value of each daily repayment of Principal Collections represents two items. The first is described by the deeds as the payment for the new receivables which have come into existence, being the sums which MBNA has advanced to its customers and paid in respect of their purchases, where those customers' accounts are designated. Its amount is the face value of those new receivables. The money so used is sometimes described in the documents as cash available for investment. The remainder—that is, the total of the Principal Collections less any sum used to make up a shortfall (but plus any surplus used to compensate for an earlier shortfall) and the face value of the new receivables is termed the "Seller's Interest". The aim is to ensure that MBNA has the full benefit of the principal collected each day—indeed, its ability to re-use the principal is a critical feature of the scheme. It is not, however, restricted in the uses to which it may put the money, which can be used to create additional receivables (by making further advances to cardholders, or by paying for their purchases), for MBNA's ordinary administrative expenses and to repay borrowings.
- The borrowings which are required by MBNA consist of assigned Receivables which have matured into Collections and which have discharged their function of standing as part of the security, only to be replaced in that role by other Receivables. Secondly, Finance Charge Collections are identified, and apportioned between MBNA, as Transferor Beneficiary, and the Investor Beneficiaries in accordance with their respective interests in the Undivided Bare Trust (we shall explain this concept more fully shortly). MBNA's share is paid to it immediately, on a day-to-day basis, while the Investor Beneficiaries' share, together with the remainder of the money included in the day's transfer, is retained in the trust account to await the monthly adjustment. The deeds provide also for some minor adjustments (in the main designed to allow for errors) which may be disregarded for present purposes.
- The payments and other adjustments CCSE is required to make are dictated by a process known informally as the "waterfall". It is designed to ensure that the various priorities dictated by the deeds are respected: most importantly, that the interest due to the investors is paid (and, during the amortisation period, that capital repayments are made) and that, after making up any shortfall in the sums due to investors (which will, as we have explained, usually be the subject of a later, balancing, adjustment) an amount equal to the Principal Collections is paid to MBNA. The system also caters for the other payments which the process of securitisation requires. There is an in-built mechanism designed to allow for occasions when the face value of new receivables exceeds the Principal Collections, and vice versa, for adjustments of earlier payments in respect of shortfalls in the funds available to meet any category of expenditure which have since been made up from the normal source of the funds used for meeting that category. We shall describe the mechanism by which these payments are accounted for at a later stage.
- The monthly adjustments are designed to allocate the Investor Beneficiaries' share of the income receipts (Finance Charges and Acquired Interchange) correctly. Some are of little or no relevance for present purposes, though we should mention that the deeds, primarily the RTSDA, cater here too for the possibility that there will be a shortfall in one or more categories of receipt, for the immediate consequences of that shortfall, and (where appropriate) for its making up from a later surplus. The arrangements are carefully designed to distinguish between different types of receipts and to allocate the payments correctly, so that the money reaches the entity or entities to which it is due, in order of priority, and that the risk of loss falls where it should. In particular, losses are borne by the investors in the commercial paper dependent on the Class C loan notes before the investors in the commercial paper dependent on the Class B and then Class A notes are affected. In somewhat truncated summary, the available money is used to pay the interest due on the commercial paper, the fees due to BCTC, CCSE and Deutsche for their participation in the arrangements, a servicing charge to which MBNA is entitled, representing the cost of servicing the accounts, and any other outgoings which have been incurred. Any surplus of income receipts over the aggregate of the sums so paid out (and we understand it was always anticipated that there would be such a surplus—indeed, securitisation is designed to ensure it) is known as "Excess Spread" and is due to MBNA. It represents the effective difference between the cost of the capital obtained by the securitisation and the income earned from it, and is MBNA's profit derived from the use of that capital. For all practical purposes, the Excess Spread is the same as the Deferred Consideration to which we have referred; it is what is left over after every other outgoing has been accommodated.
- In the amortisation period, the capital receipts are used, in whole or in part, to repay the loan notes (and correspondingly to redeem the commercial paper); the proportions which are used for that purpose and which are returned to MBNA depend upon the rate of receipt and the time over which the amortisation period is to extend. Income receipts are applied largely as before, though there are some minor variations. Although the loan notes, as we have mentioned, were issued for a relatively short initial period but with the facility for renewal, it was always in contemplation that they would be repaid within about five years; this is not an arrangement by which the loan notes can be renewed repeatedly over an indefinite period. When a securitisation has been fully amortised—that is, the loan notes have been completely repaid—the trusts are wound down, and anything remaining in them is returned to MBNA.
- The payments intended to pass between MBNA, CCSE and Deva One Limited are actually made, and are not mere bookkeeping entries: BCTC's staff act upon the daily and monthly reports by issuing instructions to CCSE's and Deva One Limited's bankers to make the necessary payments. (Since they are inactive, we ignore Deva Two Limited and Deva Three Limited for this purpose). We were provided with an elaborate diagram showing what happens, daily and monthly. It traces the daily payments from MBNA to CCSE of the Collections, their division by CCSE into the appropriate categories and their transmission to MBNA and Deva One Limited as required, with the further division of those receipts by Deva One Limited before the money, so divided, is paid either, through the conduits, to the investors or back to CCSE, which uses the money to defray the monthly expenses, passing the remainder on to MBNA. Considerable care is taken segregate the payments accurately and to calculate them to the penny.
- Securitisation is not undertaken speculatively, in the hope that investors will be found who will take up the commercial paper, but is a carefully choreographed procedure. As mentioned earlier, CCSE has no assets of its own apart from the nominal payments made by the four beneficiaries; it is quite unable, from its own resources, to pay even the initial Acceptance Price of £10,000, yet it is required to accept any offer to assign receivables which MBNA chooses to make, regardless of value, and to pay the remainder of the capital sum due following acceptance, the Further Payment, almost immediately afterwards. The commercial paper is placed so that the interval between the acceptance of MBNA's offer and the funds' becoming available is minimised, but it is impossible to eliminate the interval altogether. The funds cannot be made available until the security is in place, since the commercial paper is, of its essence, asset-backed; yet the arrangements, as we have so far described them, do not cater for the putting in place of the security without immediate payment.
- The solution is found in another feature of the arrangements, which imports a measure of flexibility, or elasticity, to accommodate not only this problem but also the fluctuation in the aggregate value of the receivables due from time to time on the securitised accounts. We have mentioned already that MBNA is described in the deeds, among other things, as the "Transferor Beneficiary". In that capacity, it is itself a beneficiary of the Receivables Trust, its interest consisting of, and being limited to, the excess of the value of the assigned receivables at any moment over the interests of the investor beneficiaries. In the event, only Deva One Limited had an interest in the trust, amounting to £500 million from the UK Series 2003-A investors. The value of that interest was fixed and the benefit of the fluctuating surplus (we understand that matters were so arranged that in all foreseeable circumstances there would be a surplus) vested in MBNA's Transferor Beneficiary interest in the trust. The deeds provide that payment by CCSE of the Acceptance Price, the Further Payment or of any other sum due to MBNA may be satisfied either by a payment of cash or by increasing the value of MBNA's Transferor Beneficiary interest.
- Accordingly, in the interval between the acceptance of an offer and the receipt of payment for the loan notes, MBNA's interest in the trust extends to all of its assets (disregarding the nominal £2 subscribed by each beneficiary); but once the capital which the securitisation is designed to procure is received from the investors and paid, via the relevant Investor Beneficiaries and CCSE to MBNA, the Investor Beneficiaries' interest has a value equivalent to the capital raised, while MBNA's interest as Transferor Beneficiary diminishes by the same amount.
- It is the same mechanism which accommodates differences between Principal Collections and the face value of new receivables, which we have previously mentioned: the Transferor Interest has a value which fluctuates daily, in line with the differences. Similarly, during the amortisation period, MBNA's Transferor Beneficiary interest in the trust can be used to accommodate differences between the amounts required to redeem the loan notes and the amounts received from its customers. The value of the Existing Receivables assigned to CCSE at the outset of a securitisation is always greater than the amount which is to be obtained from the ultimate investors, to provide a margin for fluctuations in the value of the receivables within the trust at any given moment, and in order to satisfy the rating agencies' requirement that the originator's interest in the trust property should be maintained at a minimum of five per cent. In practice, MBNA's Transferor Beneficiaries interest in the Undivided Bare Trust is a great deal higher. The total value of the trust assets is always equivalent to the face value from time to time of the Receivables within the trust. Although the calculation prescribed by the deeds of the Investor Beneficiaries' and the Transferor Beneficiaries' respective shares of that value is a little more elaborate, in order to allow for possible shortfalls and other contingencies, its effect is that the Investor Beneficiaries' interest is always of an amount equivalent to the sum received from the investors, and the remainder of the property within the trust constitutes the Transferor Beneficiaries' interest.
- A particular point with which Mr Ingram dealt in some detail in his evidence is the requirement, imposed primarily by accounting standards and the regulatory authorities but also desirable from an originator's point of view, that the risk of cardholder default be transferred from the originator to the investors. Although, as we have mentioned, there is some tailoring to meet MBNA's individual requirements, this structure follows the industry standards for money-raising securitisations, in this as in other respects. It was clear to us from Mr Ingram's evidence that risk transfer is one of the more important of the accounting requirements and that considerable care and effort was devoted to drafting the agreements in a manner which would ensure that it was achieved.
- In order to insulate an investor from the risk of the originator's insolvency, Mr Ingram claimed that there must be a true sale of the receivables so that, once they are assigned, they cannot normally be returned to the originator. There are provisions in this structure—as in others—allowing for the return of receivables which have been incorrectly assigned, because they were ineligible at the outset, and enabling MBNA to buy back "defaulted" receivables (those where the debt has remained outstanding for an excessive period) so that enforcement action can be taken; in each case there are further provisions which deal with accounting for such returns and for indemnifying the investors against losses caused by defaults (the indemnity provisions have the effect, if losses are sufficient, of indemnifying the class A note holders at the expense of the class B holders) and, in the case of defaulted receivables which are later recovered, for the money obtained to be returned to the trust and the indemnity to be reversed. As long as such provisions remain within prescribed limits, they satisfy accounting requirements and the regulatory bodies and rating agencies accept them. It is also possible, Mr Ingram told us, for an originator to "undo" a securitisation altogether, and recover the receivables then assigned.
- As far as accounting treatment is concerned, what is known by FRS5 as linked presentation is appropriate in a securitising company's accounts where there has been a transfer of risk and a significant benefit or risk has been retained. The FSA requires that a securitisation should achieve linked presentation other than in respect of matters it specifically allows. MBNA's securitisations do achieve linked presentation for it retains a right to a benefit in relation to the "sold" interest in receivables, because of the Deferred Consideration or excess spread. (That the amount of the deferred consideration / excess spread may be lower than otherwise by reason of having to make up losses is not a consideration for FRS5 purposes). Another requirement of FRS5 is that vehicles controlled by an originator such as MBNA which do not meet the legal definition of subsidiaries are to be treated as quasi-subsidiaries and included in the originator's accounts. MBNA's accounts comply with those requirements.
- We now turn to deal with the arrangements for the management of CCSE and Deva One Limited in Jersey. Both, as we have mentioned, were incorporated and have registered offices in Jersey, are owned by a Jersey trust, and have directors resident and domiciled in Jersey. Board meetings are held in Jersey. Neither has any employees, and CCSE is formally prohibited by the agreements from having any. Although Deva One Limited undertakes the tasks of issuing the loan notes and passing on payments of principal and interest, and is involved in the receipt of payments from CCSE and their return as we have described, its role is largely passive, and the focus of the debate before us was on CCSE's role and its management. MBNA's position is that the tasks which CCSE is required to undertake, of entering into the various contracts, of accepting MBNA's offers of assignments, even if only on the instructions of Deutsche, and of processing the daily and monthly instructions for the allocation of money are tasks of substance and are carried out in Jersey. BCTC's employees execute the daily and monthly instructions, and report at regular intervals at formal, minuted board meetings. BCTC's staff cannot simply follow the instructions; they have to be checked for accuracy. Mr Hollywood also emphasised that the directors' role of ensuring that CCSE's activities, as well as those of the Investor Beneficiaries, are lawful and in accordance with the agreements is no mere formality. If MBNA were to become insolvent CCSE's position would change fundamentally, since it would be required to protect the investors' interests against any possible claim by MBNA's administrator or receiver and would no longer be able to rely on MBNA's servicing the Designated Accounts; the possibility might be remote, but it is real and its existence demonstrates that CCSE is not a mere instrument of MBNA compelled to carry out its instructions regardless. (CCSE's own assets, limited though they are, are protected in the event of MBNA's insolvency.)
- Mr Paines accepted that CCSE had a Jersey registered office and Jersey directors. The Commissioners' position, as he put it, is that the Jersey companies were created by MBNA and all came into existence for no reason other than to participate in the securitisations, and to do so entirely in accordance with instructions given by MBNA or its professional advisers. They do not have, and are excluded from exercising, any discretion. It cannot realistically be said that any of them does anything other than mechanically execute the instructions they are given. None has facilities of its own, in the form of employees or offices; they are merely vehicles created and controlled by MBNA for its own purposes. Thus while it may be true to say that they have a Jersey presence in a formal sense, they have no substance in Jersey; all of the real tasks necessary for their functioning are carried out by MBNA at its UK headquarters in Chester and are merely executed in Jersey, and even then not by CCSE itself but by BCTC. If MBNA became insolvent the true burden of stepping in, to protect the investors and service the accounts, would fall not on CCSE but on Deutsche; CCSE would simply follow Deutsche's instructions instead.
- We agree with the COBE tribunal that there is some merit in both parties' arguments. It is true that the Jersey companies have no raison d'être other than the securitisation, that CCSE must follow Deutsche's, and MBNA's instructions without exercising any discretion or judgment of its own, and that it has no means of functioning (nor any function to perform) which is independent, and not driven by its interests. We are sure Bedell Cristin did review the documentation, but in order to ensure that it posed no problems for BCTC or its directors, in that capacity; it is in our view quite artificial to claim that there was any meaningful consideration of the documents by, or on behalf of, CCSE itself when it was created for no purpose other than to enter into them and there was no possibility, beyond the fanciful, that it would not do so. We consider too that, in practical terms, CCSE's position would be little changed if MBNA were to become insolvent: it is a bare trustee, and its own assets are protected. On the other hand, we do not think we can overlook the facts that CCSE and the other companies are incorporated in Jersey, that they have their own directors, independent of MBNA, who hold real meetings and that, albeit it has procured (even if as part of the overall scheme) that they are actually performed by BCTC's employees, CCSE carries out daily and monthly tasks. Since this issue cannot be decided without a consideration of the relevant case-law we shall set out our findings on it later in this decision.
Summary of the above findings of fact
- We are satisfied that securitisation is a well-established means by which financial institutions raise funds, that it is frequently and extensively used (we were told that the value of the securitisation market in the UK in 2004 amounted to about €100 billion), that there are recognised industry standards and that there is nothing out of the ordinary in the structure used by MBNA. The tensions between the various commercial, accounting and regulatory requirements which must be met present the draftsman of such a scheme with formidable problems, and add considerably to the complexity of the structure; we are not persuaded that there is anything in this structure—apart from the added complexity attributable to the need to respect dual regulatory and accounting standards to which we have referred—which differentiates it in any way from the norm.
- The essential purpose of a securitisation, as we perceive it, is to enable the originator to obtain working capital at the lowest possible cost: in other words, the more an originator such as MBNA, whose business is, in essence, lending to retail customers, can secure as working capital, the more it can lend, and the greater the difference between the cost of securing that working capital and the income it derives from lending, the greater the profit. The lowest possible cost of securing funds is achieved by the originator's putting up debts owed to it which are used, directly or indirectly, as security for a borrowing; whether it is the originator which is using the debts as security is an issue of law we must decide. Since working capital is of limited value to the originator if it has to be returned in a short time, a means must be devised of enabling the originator to use, and profit from, the money received in discharge of the debts while at the same time replenishing the stock of debts used to provide the security. Whether the replenishment amounts to a sale, or series of sales, is a further issue of law we must decide.
- An additional critical feature of the process of securitisation is the manner in which it accomplishes the transfer of one form of risk, of exceptional cardholder default (exceptional, that is, when measured against the predicted level for which the arrangements cater and which the agency ratings allow), as well as the possibility that significantly more than predicted cardholders will pay off the full balance owed by them each month, and thereby incur no interest charges, while "ring-fencing" another (of originator insolvency). Those ultimately providing the funds must be isolated from the risk of the originator's insolvency, and at the same time the risk of excessive debtor default must be removed from the originator. The securitisation with which we are concerned, we are satisfied, achieves those objectives.
- We should also record that the structure of this securitisation was designed and created by MBNA (through Mr Ingram's agency) to suit MBNA's needs, and that the manner in which it was operated, both in the inception of each individual securitisation and in its application to those securitisations, was throughout dictated by MBNA. None of CCSE, Deva One Limited or the other Investor Beneficiaries was able to influence the shape of the structure in any way. We heard no evidence about any influence the conduits may have had, but we think it probable that they, like the rating agencies and the ultimate investors, shaped the structure only in the sense that MBNA was conscious of the requirements it must satisfy. Those requirements were of a standard nature, without modification peculiar to these securitisations.
The Agreed Method
- Not long after MBNA began trading, to be precise on 24 November 1994, it entered into a PESM with the Commissioners. It was based on non-EU credit card usage. Six months later, on 23 May 1995, it informed the Commissioners that it was about to start securitisations, and did so in August of that year. Notwithstanding that change in MBNA's arrangements for raising working capital, the 1994 PESM remained in force until 1999.
- Following protracted discussions between the parties, starting in about 1996, in which the Commissioners sought to address the impact of securitisation on MBNA's input tax recovery, the Commissioners prepared and sent to its accountants, PricewaterhouseCoopers (then known as Coopers & Lybrand) ("PWC"), a draft PESM/regulation 103 agreement letter setting out the terms and conditions that would be acceptable to them, the Commissioners. After two modifications to specific terms suggested by PWC, the parties agreed terms and a letter containing them was dispatched by the Commissioners on 19 November 1999. The letter stated that it had retrospective effect to 1 July 1998, and that the method agreed, which was of course the Agreed Method, was to remain in use by MBNA until such time as the Commissioners approved or directed its termination.
- The letter of 19 November 1999 was expressed to be an exercise by the Commissioners of their powers under regulation 102(1) of the Regulations. However, as the parties now acknowledge in the light of the House of Lords decision in LIPA, it was only in part an exercise of the regulation 102 power. As it also covered supplies outside the UK for which there is a right to deduct under section 26(2) of VATA and regulation 103 ("specified supplies"), it also involved an exercise of the Commissioners' power to enter into an agreement attributing input tax under regulation 103. (That power is to be found in paragraph 1(1) of Schedule 11 to VATA).
- The Agreed Method required direct attribution wherever possible, with the use of a values based fraction to calculate the deductible proportion of residual input tax. It defined "taxable supplies" as meaning all supplies for which there is a right to deduct under section 26(2) of VATA, and "exempt supplies" as meaning all other supplies. Therefore "taxable supplies" included "specified supplies" described in article 3 of the Value Added Tax (Input Tax) (Specified Supplies) Order 1999. "Specified supplies" include supplies of certain financial services supplied to a person who "belongs" outside the European Union. Such supplies are exempt from output VAT, but carry a right to deduct input tax as provided for in regulation 103. The values based fraction had certain sums expressly excluded from it. Those exclusions relevant to the present appeal are to be found at clauses 3(a) and (b) of the Agreed Method and to put them into their context, we should perhaps set out the whole of the 19 November 1999 letter, excluding introductory and other irrelevant matters. It reads as follows:
"2. Your tax year begins on 1 April and ends on 31 March. With effect from 1 July 1998, you are to calculate your deductible input tax in respect of each prescribed accounting period on the following basis:
(a) Identify all the goods and services you receive which are used, or to be used, by you exclusively in making taxable supplies. The input tax thereon is deductible.
(b) Identify all the goods and services which are used, or to be used, by you exclusively in making exempt supplies or in carrying on an activity other than the making of taxable supplies. The input tax thereon is not deductible.
(c) The deductible proportion of any input tax incurred on goods and services which are used in making both taxable and exempt supplies shall be in the ratio that the values of taxable supplies bears to the values of taxable and exempt supplies. This proportion shall be expressed as a percentage and, if that percentage is not a whole number, it shall be rounded up to the next whole number.
3. In calculating the proportion under paragraph 2(c) above, there shall be excluded, in addition to all those supplies specified in regulation 101(3) of the Value Added Tax Regulations 1995, any sum receivable from -
(a) the transfer or the assignment of debts, receivables or future receivables but not the values of supplies of servicer services;
(b) cardholders whose account is, at that particular time, the subject of securitisation arrangements;
(c) investment income arising from amounts deposited and invested; and
(d) foreign exchange transactions.
It is agreed that late and over limit fees are consideration for supplies of services and are not to be excluded from the proportional calculation at paragraph 2(c) above.
4. Values of supplies of services which were prior to 1 January 1993 either zero rated or exempt but which are now outside the scope of UK VAT but with a right to deduct and no right to deduct respectively are to be included (unless specifically excluded as a distorting supply) in the values based proportional calculations set out at (c) above.
Please note that for the purposes of this special method, the expressions –
(a) "Taxable supplies" mean all those supplies for which there is right to deduct under S26(2) of the Value Added Tax Act 1994.
5. At the end of each tax year you are to carry out an annual adjustment using the figures for the whole tax year. Any difference between the amount of deductible input tax recalculated at the end of the tax year and the total amount provisionally deducted during the year is an over or under declaration of tax. This amount must be entered in your VAT account for the first tax period after the end of the tax year.
If the recalculation shows that input tax attributable to supplies for which there is no right to deduct is below the limits set out in regulation 106 of the Value Added Tax Regulations 1995, you are treated as being fully taxable for the tax year. Any input tax not claimed during the tax year is an under-deduction of tax.
6. The method is to be used until such time that Customs and Excise approve or direct the termination of its use.
7. You must advise this office immediately of any change in your business which may have a significant effect on the amount of input tax that you can claim."
- Thus the values based fraction provided for the following calculation of the deductibles proportion of residual input tax:
Value of specified supplies + value of taxable supplies
Value of all supplies
subject to the agreed inclusions and exclusions.
- In May 2002 the Commissioners instituted a review of the Agreed Method, MBNA being informed of the review at a meeting on 7 May 2002. At the meeting the Commissioners expressed their concerns as to whether the Agreed Method was producing fair and reasonable residual input tax attribution, but nothing more was done at the time. There was then correspondence between the parties which included a claim made by PWC on 4 November 2002 that there was no justification for the Commissioners to seek to change the Agreed Method. PWC maintained that it provided for a recovery rate that reflected the tax incurred in making supplies with a right of recovery, and that its principles were soundly based. On 23 December 2002 the Commissioners wrote to PWC regretting the lack of "meaningful discussions", and expressing the hope that a new mutually satisfactory method could be agreed. They also indicated that they were minded to withdraw the Agreed Method with effect from 1 April 2003 and to direct a new PESM under regulation 102 to determine a fair and reasonable level of recovery of input tax on MBNA's UK taxable supplies. PWC then sought, and were granted, an extension of time to enable them to show the nexus between the levels of servicer charges made in respect of designated accounts and the levels of VAT recovered by MBNA, those being the matters on which the Commissioners required information. But when PWC submitted their report, the Commissioners maintained that they failed to produce the data on which their conclusions were based. PWC further indicated that there was no prospect of a new method being agreed, and declined to propose any alternative to the Agreed Method. And in a letter of 6 June 2003, PWC contended that MBNA had failed to exclude amounts that, according to a new interpretation by PWC of the terms of the Agreed Method, it should have excluded from the denominator of the fraction for which it provided. The letter indicated that a voluntary disclosure would be made once the amount of the claim had been calculated. The new interpretation excluded, under paragraph 3(b) of the Agreed Method, interest and finance charges made on cardholders which were not actually received prior to securitisation of their accounts. On 30 June 2003 the Commissioners wrote to MBNA terminating the Agreed Method with effect from 1 July 2003. They did not direct a replacement method as they had no power to direct a method of attribution under regulation 103. As to taxable supplies, properly so called, MBNA reverted to the standard method for which regulation 101 provides, and its calculations under that regulation are not in issue.
- In a letter which accompanied the voluntary disclosure, PWC explained:
"The basis of our client's input tax recovery method was summarised in a letter of 19 November 1999 issued by the Commissioners. In determining the recoverable element of unattributable input tax the calculation was based on outputs with certain specified exclusions. Of particular relevance to this claim is the exclusion listed at paragraph 3(b) of the letter. This clause specifies that any such receivables from a cardholder whose account is at that particular time the subject of securitisation arrangements could be excluded from the calculations.
MBNA's accounting system recognises income when interest and other finance charges are levied on the cardholders."
The voluntary disclosure
- On 31 July 2003 PWC submitted a voluntary disclosure on behalf of MBNA covering the 36 monthly accounting periods from April 2000 to March 2003 inclusive. In it MBNA claimed to have applied incorrectly the exclusion at paragraph 3(b) of the Agreed Method, as explained in the last preceding paragraph, resulting in it having claimed less input tax than that to which it was entitled. The recalculation had a significant effect on MBNA's residual input tax recovery rate, increasing it in the year commencing 1 April 2002 from 23 per cent to 44 per cent.
- There was then further correspondence between the parties in which the Commissioners raised the point that MBNA's input tax claim for the periods April, May and June 2000 was capped by regulation 29 of the Regulations. (Since then, the Commissioners have accepted that the voluntary disclosure was received by them on 31 July 2003 so that the claim for June 2000 was made timeously). On 3 December 2003, the Commissioners declined to authorise payment of the claim in the voluntary disclosure.
MBNA's approach to making returns following withdrawal of the 1999 method
- From July 2003 until about December 2003, MBNA made its VAT returns as if the Agreed Method remained in force, in particular maintaining the interpretation of paragraph 3(b) propounded in the voluntary disclosure.
- From about December 2003, MBNA correctly made its returns using two separate calculations to attribute input tax, one under regulation 103 and the other under regulation 101. It calculated its recovery ratio under regulation 103 using the fraction:
Value of specified supplies
Value of all supplies
still subject to the express inclusions and exclusions contained in the Agreed Method, as interpreted in the voluntary disclosure.
- MBNA carried out a second calculation relating to input tax deductible in making taxable (i.e. in-country taxable) supplies, applying regulation 101(2)(d) for the purpose.
- The regulation 101(2)(d) calculation for every prescribed period from July 2003 to December 2004 produced a recovery ratio well below 1 per cent, but as regulation 101(4) requires that ratio to be rounded up to the next whole number, its claim was rounded up to one per cent. If it was the case, as the Commissioners submit, that regulation 101 was applicable in relation to those periods, it is common ground that MBNA is entitled to recover 1 per cent of its residual input tax not attributed under regulation 103.
The decision to inhibit
- PWC advised the Commissioners of the basis on which MBNA had calculated (and would continue to calculate) its input tax deduction in the periods from July 2003 onwards. Each of its returns submitted to December 2004, with the exception of that for April 2004, showed a new repayment claim. On 27 November 2003 the Commissioners informed MBNA by letter that its returns for the periods from 31 July 2003 had been "inhibited".
The remaining facts
- By letter of 2 June 2005 the Commissioners notified MBNA of assessments to VAT for the 18 consecutive prescribed periods commencing with that for July 2003, maintaining that its returns had been incorrect.
- On 1 August 2002 MBNA acquired a portfolio of credit card accounts from Alliance and Leicester plc and shortly thereafter a portfolio from Co-operative Bank plc and in each case the disposing company contracted to continue servicing the accounts in question. The evidence adduced did not indicate precisely what services were provided by the disposing companies, so that we are unable to compare the arrangements made by MBNA with them for which paragraph 9 of the RTDSA provides.
- MBNA outsourced some of the servicing arrangements it had undertaken to provide, in part to Experian Limited and in part to another American subsidiary of MBNA
Methods of Attribution
- MBNA put forward the following five other methods of attribution it considered fair and reasonable, all of which would have allowed it to recover a higher percentage of residual input tax than the 25 per cent it claimed it was entitled to recover under the Agreed Method.
- The percentage of residual input tax recoverable by MBNA under each of those methods, as it itself has been calculated, is as follows:-
(2) The Agreed Method was interpreted by MBNA
Servicer fee + non-EU interchange
Total income – income arising on designated accounts
Yields 35 per cent recovery of residual input tax
(3) An outputs method where the only exclusion in the assignment of principal receivables
Servicer fee + non-EU interchange + future finance charge receivables
Total income
Yields 45 per cent recovery of residual input tax
(4) A method as at (2) but excluding the value of assignments of future finance charge receivables and including excess spread
Servicer fee + non-EU interchange + express spread
Total income
Yields 26 per cent recovery of residual input tax
(5) A method excluding interest and finance charges arising on accounts
Servicer fee + non-EU interchange
Servicer fee + all interchange + personal loan interest + insurance commissions
Yields 40 per cent recovery of residual input tax
(6) A very "broad brush" method using the ratio of servicer fee to total business costs from MBNA's profit and loss account
Yields 26 per cent recovery of residual input tax
The Legislation
- In the introduction to our decision, we summarised the domestic legislation relevant to MBNA's input tax claim, other than that relating to the capping point. We proceed to consider the remainder of both the Community and domestic legislation in detail and shall deal with that relating to capping at the appropriate point in our decision. Since the domestic legislation must be interpreted so far as possible to give effect to the EC Sixth Directive (EC/77/388), we first consider the relevant parts of the latter.
- Article 17 deals with the origin and scope of the right to deduct input tax. Article 17.2 provides:
"2. In so far as the goods and services are used for the purposes of his taxable transactions, the taxable person shall be entitled to deduct from the tax which he is liable to pay:
(a) value added tax due or paid in respect of goods or services supplied or to be supplied to him by another taxable person; …"
- Article 17.5 covers mixed inputs. It provides:
"5. As regards goods and services to be used by a taxable person both for transactions covered by paragraphs 2 and 3, in respect of which VAT is deductible, and for transactions in respect of which VAT is not deductible, only such proportion of the VAT shall be deductible as is attributable to the former transactions.
This proportion shall be determined, in accordance with Article 19, for all the transactions carried out by the taxable person."
However Member states may:
(b) authorise or compel the taxable person to make the deduction on the basis of the use of all or part of the goods or services; …"
- Article 19 provides for the proportion deductible for mixed use inputs under article 17.5 to be determined by reference to turnover, using the fraction:
turnover from transactions with the right to deduct
total turnover
- Those provisions of the Sixth Directive have been implemented in VATA. Section 24 thereof defines "input tax" in terms of goods or services "used for the purpose of a business". Section 25 confers an entitlement to credit for input tax allowable under Section 26. Section 26 (1) provides:
"(1) The amount of input tax for which a taxable person is entitled to credit at the end of any period shall be so much of the input tax for the period … as is allowable by or under regulations as being attributable to supplies within subsection (2) below."
Subsection (2) covers taxable supplies and certain supplies outside the UK. Under subsection (3):
"(3) The Commissioners shall make regulations for securing a fair and reasonable attribution of tax to supplies within subsection (2) …"
- The relevant regulations are the Value Added Tax Regulations 1995 (1995 S.I. No. 2518). Regulation 101 lays down the "standard method", which applies subject to regulation 102. Under paragraph (1) of regulation 101:
"(1) Subject to regulation 102, the amount of input tax which a taxable person shall be entitled to deduct provisionally shall be that amount which is attributable to taxable supplies in accordance with this regulation."
Under subparagraphs (2)(b) and (c) of regulation 101 all of the input tax on goods and services used exclusively in the making of taxable supplies is attributed to such supplies (and is thus deductible) but none of the input tax on supplies used exclusively in making exempt supplies is so attributed. Subparagraph (d) applies to mixed supplies. It provides:
"(d) there shall be attributed to taxable supplies such proportion of the input tax on such of those goods and services as are used or to be used in making both taxable and exempt supplies as bears the same ratio to the total of such input tax as the value of taxable supplies made by him bears to the value of all supplies made by him in the period."
Paragraph (3), which provides for certain exclusions in calculating the proportion under sub paragraph (2)(d) is not relevant to the appeal.
- Regulation 102 provides:
"(1) Subject to paragraph (2) below and regulation 103, the Commissioners may approve or direct use by a taxable person of a method other than that specified in regulation 101 …"
(The latter part of regulation 102(1) is not material to this appeal).
"(2) Notwithstanding any provision of any method approved or directed to be used under this regulation which purports to have the contrary effect, in calculating the proportion of any input tax goods or services used or to be used by the taxable person in making both taxable or exempt supplies which is to be treated as attributable to taxable supplies, the value of any supply within regulation 101(3) shall be excluded.
(3) A taxable person using a method as approved or directed to be used by the Commissioners under paragraph (1) above shall continue to use that method unless the Commissioners approve or direct the termination of its use.
(4) Any direction under paragraph (1) or (3) above shall take effect from the date upon which the Commissioners give such direction or from such later date as they may specify."
- Regulation 103, which deals with out-of-country supplies, in its form in force to 1 December 2004, provided:
"(1) Input tax incurred by a taxable person in any prescribed accounting period on goods imported or acquired by, or goods or services supplies to, him which are used or to be used by him in whole or in part in making –
(a) supplies outside the United Kingdom which would be taxable supplies if made in the United Kingdom, or
(b) supplies specified in an Order under section 26(2)(c) of the Act, [other than supplies of a description falling within regulation 103A below,]
shall be attributed to taxable supplies to the extent that the goods or services are so used or to be used expressed as a proportion of the whole use or intended use.
(2) Where -
(a) input tax of the description in paragraph (1) above has been incurred on goods or services which are used or to be used in making both –
(i) a supply within item 1 or 6 of Group 5 of Schedule 9 to the Act, and
(ii) any other supply, and
(b) the supply mentioned in sub-paragraph (a)(i) above is incidental to one or more of the taxable person's business activities,
that input tax shall be attributed to taxable supplies in accordance with paragraph (1) above notwithstanding any provision of any method that the taxable person is required or allowed to use under this Part of these regulations which purports to have the contrary effect"
(Group 5 of the said Schedule 9 to VATA deals with finance)
(1) Withdrawal of the Agreed Method
(1)(a) Was the Agreed Method validly withdrawn?
- Before dealing with the parties submissions in relation to the question of whether the Commissioners validly withdrew the Agreed Method, we should perhaps record that it was common ground that regulation 102 empowered the Commissioners to approve or direct the use of a PESM, as well as to approve or direct its termination; and that by paragraph 1(1) of Schedule 11 to VATA they might enter into an agreement with a taxpayer as to how attribution of input tax to foreign and specified supplies was to be carried out, Royal and Sun Alliance plc v The Commissioners (2004) Decision No. 18842. It also appeared to be agreed that VATA empowered the Commissioners to make a PESM or regulation 103 agreement for a definite or indefinite period, and in the latter case to include a power of revocation; but that VATA contained nothing enabling the Commissioners to direct a taxpayer as to how to attribute input tax to foreign or specified supplies.
- In Cliff College Outreach v The Commissioners (2001) Decision No. 17301 (which was followed in University of Exeter v The Commissioners (2003) Decision No. 18117), the tribunal could find no limitation on the Commissioners' power to withdraw approval of a PESM, but accepted that they could not do so were the result to force a trader to use an even more unsatisfactory method, even if that method were the standard method. Nor could it find support for the proposition that there must be a change in circumstances for the Commissioners to be able to rescind their approval of a PESM. Whilst accepting that such a change might warrant rescission, the tribunal observed that a method which appeared likely to yield a fair result might in practice not do so; and, in those circumstances, it expressed the view that it would:
"find it remarkable if the Commissioners were nevertheless compelled to allow a trader to continue using that method (or a trader compelled to continue using it) merely because no changes in circumstances could be established. Indeed [the taxpayer] conceded in argument that the Commissioners could not be bound by a mistake, and would be at liberty to require a trader to use a better method if one were available."
- On the basis of the Cliff College decision, Mr Paines submitted that the identification of a flaw in either a PESM or a regulation 103 agreement was sufficient for the Commissioners to withdraw it; and, whilst it was possible for the standard method (requiring attribution on the basis of the value of outputs) to be less satisfactory in a particular case than an existing special method, it was not conceptually possible for regulation 103 (requiring attribution on the basis of use) to require less satisfactory attribution than a flawed agreement.
- He submitted that the Agreed Method was flawed if for no reason other than as a matter of law it wrongly excluded the value of supplies to designated cardholders from the denominator of the partial exemption fraction, thus wrongly inflating MBNA's recovery proportion. Mr Cordara countered that an output values based method did not have to include all outputs. We accept that as a general proposition, but not as applicable in the instant case. Against the background of the Agreed Method, Mr Paines went on to develop his point by explaining that it was common ground that the supplies of consumer credit by MBNA to non-designated cardholders were exempt supplies. But whereas the Commissioners maintained that supplies to designated cardholders were likewise exempt supplies, Mr Cordara contended that collections on such accounts were either trust property or the right to receive receivables was assigned to the receivables trustee, and thus repayment was not consideration in MBNA's hands. Mr Cordara based his argument in that behalf on the contents of Schedule 10 to VATA and certain observations of Lord Slynn at page 93 of his speech in Nell Gwynn House Maintenance Fund v Customs and Excise Commissioners [1999] STC 79 indicating that paragraph 8 of that schedule was aimed at treating input tax attributable to a grant of land as that of the grantor of an interest who did not hold the legal estate in the land. In that case, the appellant company, although not the landlord, made certain maintenance contributions in respect of a block of flats and successfully claimed that, by virtue of paragraph 8 of Schedule 10 to VATA, it was to be treated as if it had granted a lease. (Paragraph 8 provides that:
"Where the benefit of the consideration for the grant of an interest in, right over or licence to occupy land accrues to a person and that person is not the person making the grant –
(a) the person to whom the benefit accrues shall for the purposes of this Act be treated as the person making the grant …").
- As we understood him, Mr Cordara claimed that, as Community legislation made no provision for paragraph 8 of Schedule 10, it must be part of the general VAT system, and the principle involved must be equally applicable to intangible property. We are unable to accept his claim in that behalf. Article 13C of the Sixth Directive allows Member States a discretion to tax (a) transactions in land and (b) the granting of credit (see article 13B(d)), and to impose restrictions. The United Kingdom has chosen to allow taxpayers to opt to tax transactions in land, but not to tax credit transactions. Mr Cordara's argument would seem to proceed on the basis that because the UK has adopted the derogation in article 13C in one respect, it must be treated as having done so in every respect. We know of no principle of interpretation to that effect.
- In COBE, the tribunal, rightly in Mr Paines' submission, accepted that the value of its supplies to its customers was to be included in its calculation of recoverable residual input tax, finding it to be effectively conceded by COBE and the contrary to be unarguable (see paragraphs 160-162 of COBE). He maintained that MBNA could not contend that it did not use residual inputs in making exempt supplies to designated cardholders. It accepted that it used such inputs in making supplies to non-designated cardholders, since it supported the inclusion of their values in the Agreed Method. Mr Paines contended that there was no difference between what MBNA did in respect of a designated account and a subsisting non-designated account – indeed, it did not know which accounts had been designated. On that ground alone, he submitted that MBNA was wrong to claim that the Agreed Method properly expressed the attribution required and permitted under regulation 103.
- On what appeared to Mr Paines to be the theory that the omission of the value of exempt supplies to designated cardholders – which reduced the denominator of the partial exemption fraction and thus increased the recoverable proportion of residual input tax – was balanced by the exclusion from the fraction of specified supplies (the assignment of receivables) which reduced the recoverable proportion of input tax, MBNA claimed that the exclusion under paragraphs 3(b) and (c) of the Agreed Method of both the value of assignments of receivables and the value of exempt supplies to designated cardholders constituted, by implication, a satisfactory compromise in relation to the treatment of the process of securitisation. Mr Paines rejected such a theory on the basis that assignments of receivables under a securitisation were not supplies for VAT purposes. He maintained that MBNA's contentions could be correct only were either the advance of credit to the cardholder to be made by CCSE, or no consideration in the form of payment and interest and charges were to be received by MBNA – neither of which was the case. The receivables trustee was not a party to any transaction between MBNA and the cardholder, or vice versa, and the cardholder did not even know that his account had been designated, unless he had been served with notice of assignment following a 'notification event' – a situation which had never occurred. The trustee did not obtain from MBNA any power to grant credit to MBNA's cardholders: all that was assigned to the trustee was the receivables arising on designated accounts. However, as between MBNA and the cardholder, the transaction remained one under which MBNA provided a supply of credit for a consideration to be provided by the cardholder to MBNA. Mr Paines submitted that a taxable person who had entered into such a transaction could not prevent the consideration provided by the other party being consideration received by him simply by entering into a separate arrangement with a third party (the trustee) to pass the money on to that third person. Nor did it make any difference that the separate arrangement with the third party was underpinned by equitable obligations. If it were otherwise any taxable person could avoid liability to tax by declaring a trust of his VATable receipts.
- The correct approach to dealing with MBNA's input tax claim was, in Mr Cordara's contrasting submission, a balanced one informed by common sense. Dealing first with the Agreed Method, he observed that it represented a compromise between the parties, and claimed that the compromise had been reached on the basis that MBNA was required to bring into calculation only that part of its turnover it retained, i.e. the value of the servicer services on designated accounts. If we were to accept that that was the effect of paragraph 3 of the Agreed Method, and that there had been no change in MBNA's circumstances, he submitted that the Commissioners could not validly withdraw the Agreed Method.
- Secondly, Mr Cordara relied on the decision of the tribunal in the case of Merchant Navy Officers Pension Fund Trustees Limited and another v Customs and Excise Commissioners (1996) Decision No. 14262. That appeal concerned attribution as between taxable and exempt supplies under regulation 101, and not specified supplies under regulation 103. The Commissioners directed that the Appellant should cease to use a PESM under regulation 102 so that the issue was whether the PESM had achieved a fair and reasonable result. The tribunal analysed the principles of attribution between different categories of supplies in the following way:
"20. The basic rule laid down by Article 19 [of the Sixth Directive] is that mixed use inputs are to be apportioned to taxable and exempt supplies in the ratio of taxable outputs: total outputs, subject to specified exclusions. Articles 17.5 and 19 are concerned only with mixed use inputs. Inputs used exclusively for taxable or exempt outputs are not covered by Article 17.5 and 19: if used for taxable supplies they are deductible under Article 17.2; otherwise they are not deductible.
21. It is important to note that the basic scheme of Article 17.2 is to allow deduction on the basis of use or intended use. Usually there will be a direct connection between inputs and outputs, as with goods purchased for resale. However, there is no necessary quantitative link: clothes bought for resale may go out of fashion. The input may be an indirect cost component such as a shop's electricity bill. The essence is that the goods or services are used or in the French "utilises" for taxable supplies.
22. Inputs directly used for taxable or exempt supplies present no problem. The problem arises with overheads and other indirect costs. It also arises however with inputs which could in part or in whole be attributed on the basis of actual use but where such attribution would be burdensome or difficult to check: an example might be telephone calls.
23. Once attribution on the basis of actual use is impossible or impractical any other method of attribution can only be designed to approximate to actual use being only estimated or assumed. The standard method is very rough and ready and may result in attribution which is demonstrably very different from probable actual use however it has the important merit of simplicity.
24. The methods authorised under Article 17.5(c) are clearly different from that under Article 19, since otherwise Article 17.5(c) would be otiose. However, it cannot mean actual direct use since, if the actual use of the input could be determined, it would not be a mixed use and Article 17.5 would not apply at all. It seems to me that Article 17.5(c) must authorise attribution on the basis of estimated or assumed use.
25. In my judgment regulation 102 empowers the Commissioners to direct or allow a method designed to attribute inputs fairly or reasonably on the basis of assumed or estimated use. The words "fair and reasonable" in section 26(3) qualify "attribution of input tax to supplies"; however in my judgment they apply not only to the resultant attribution but also to the method. The method must be reasonable for the trader to operate, in that it does not involve disproportionate or unreasonable resources, and it should be capable of being checked by Commissioners again without unreasonable effort. Inevitably if the business is complex and large sums are involved, the operation of any special method will be complex. Requirements which are reasonable for a pension fund with 50,000 beneficiaries might be excessive and unreasonable for a fund with only 100. The result must be reasonable; however this may be over a number of periods as opposed to each individual period.
26. As mentioned already it was suggested that the Tribunal should only consider whether the 1991 method was operating in a fair and reasonable manner. The difficulty with this approach is what is fair and reasonable is not an absolute concept and will frequently depend on the alternatives. It seems to me that when exercising their discretion under regulation 102(3) the Commissioners must consider what alternatives there are to the method proposed or the method to be terminated. The Commissioners would not be using their powers to secure a fair and reasonable attribution if the decision to terminate resulted in the use of a method which is less fair and reasonable. It seems to me that the Tribunal must do the same when exercising a full appellate jurisdiction; indeed the Tribunal would have to do the same if its jurisdiction was limited to considering whether a direction (or refusal to approve or vary a method) was unreasonable in the Corbitt sense. A decision resulting in a method which is less fair and reasonable would itself be unreasonable.
27. In an appeal such as the present where there has been a two day hearing the Tribunal may have more information than the Commissioners had when making their direction. On the other hand, the material available to the Tribunal is limited to the evidence adduced."
- In reliance on the principles enunciated in the Merchant Navy case, Mr Cordara maintained that the Agreed Method was the fixed and trusted methodology in the instant case. It had been reached by the parties in 1999 following full disclosure by MBNA. There was no suggestion of any change in the company's circumstances by the Commissioners. The Agreed Method had been operated. It was therefore a fair and reasonable proxy, and the Commissioners could not validly withdraw it.
- Mr Cordara developed the "Merchant Navy approach" by submitting that all the residual input tax identified by MBNA had a direct and immediate link to all the outputs of its business. Under regulation 103, one looked for a methodology of attributing the use of goods to specified supplies when compared to overall use; overall use being the denominator of the partial exemption fraction. (He observed that out of country exempt supplies were dealt with under regulation 101 so that the numerator in the regulation 103 fraction did not include them; but the denominator in that fraction included everything). He maintained that a "holistic approach" such as that determined upon by the tribunal in National Provident Institution v Customs and Excise Commissioners (2004) Decision No 18944, was appropriate in the instant case. (In that case the Institution was in dispute with the Commissioners as to the appropriate methodology for apportioning its residual input tax between in-country exempt supplies to its policy holders and its investment income outside the EU where it was making supplies outside the scope of VAT but with recovery. NPI contended that the appropriate proxy for use was its turnover across the board; the Commissioners responded that such an approach should be used under regulation 101 but that there should be a 17-step employee numbers based approach under regulation 103. The tribunal held that a turnover based approach was appropriate in both cases). Mr Cordara suggested that in dealing with cases such as the instant one, one should take the sentiments expressed in the Merchant Navy case and apply them to regulations 101, 102 and 103: the result would be a method consisting of a combination of regulations 101 and 103, or regulations 102 and 103. One should then look at the total conclusion and apply a single test, namely that of the Merchant Navy case as applied in National Provident Institution.
- We have no hesitation in accepting the Merchant Navy tribunal's conclusion that it follows from the express direction to the Commissioners in section 26(3) of VATA that they "shall make regulations for securing a fair and reasonable attribution of input tax" to taxable supplies that they have that objective before them when directing or approving a PESM and / or agreement under regulation 103. And we accept that, in the absence of a PESM for in-country supplies, a taxpayer has to use the standard method for which regulation 101 provides.
- At paragraph 23 of its decision, the Merchant Navy tribunal described the standard method as being rough and ready, although apparently satisfying articles 17(5) and 19 of the Sixth Directive. It also conceded that any method of trying to gauge the measure whereby supplies used for mixed purposes should be treated as taxable supplies could only be approximate. In those circumstances a practical solution is called for, and there may well be more than one way of arriving at a measure of estimating taxable use, each of which may be capable of producing a fair and reasonable attribution. That being so, can it be said that any of those methods is incorrect? What is the measure of correctness? Strictly, the only test is whether the chosen method is rationally capable of producing a fair attribution. As the judgment in Victoria and Albert Museum Trustees v Customs and Excise Commissioners [1996] STC 1016 shows, in choosing a valid method, a taxpayer is not in error in having chosen one method when another method would have allowed it more credit.
- A taxpayer has a right to deduction for VAT incurred on supplies used or to be used in making taxable supplies, using that expression to include specified supplies. It will normally suggest a method that maximises its recovery, and is entitled to do so in furtherance of its Community rights. If the suggested method passes the rationality test, the Commissioners cannot reject it on the basis that another rational method would justify giving less relief. But that does not mean that in directing a PESM (or in reaching a regulation 103 agreement), the Commissioners are bound to seek and consider all conceivable methods and choose the one that gives most credit. The obligation on them is to fix upon a method that can be demonstrated as producing a fair and reasonable attribution, that being the taxpayer's entitlement.
- We are unable to accept that in deciding to terminate a PESM without at the same time directing another one the Commissioners have necessarily determined that the standard method in regulation 101 operating by default produces a fair and reasonable result. Faced with a situation where a PESM (or for that matter a regulation 103 agreement) is for any reason seen as not giving such a result, they are obliged, because the taxpayer is exceeding its rights, to terminate it. Cases such as that of Aspinalls Club Limited v Customs and Excise Commissioners (2002) Decision No. 17797 show that a method agreed as likely to produce a fair and reasonable way of attributing residual input tax can produce a grotesquely high recovery rate when for example, a trader making predominantly exempt supplies has incurred exceptional expenditure on, say, major construction works. The Commissioners cannot take retrospective action to prevent a loss of tax which has already occurred. They may well not have the facts, or not be able to obtain them within a reasonable time, to direct a new PESM there and then.
- In our judgment, in withdrawing a PESM or regulation 103 agreement, the Commissioners are simply deciding that the method concerned does not produce a fair and reasonable attribution. As a matter of law, they cannot require a taxpayer to put forward for approval a new and different method. The taxpayer can, as MBNA has done, appeal their decision and contend that the old method is still a good one. Alternatively, the taxpayer can put forward a new method or methods, again as MBNA has done, claiming to show how, in the circumstances of its business (which it may be taken to know better than the Commissioners), it produces a fair and reasonable result. In our judgment, contrary to what may be the Commissioners' actual view, they are not to be taken to have decided that, in so far as in-country supplies are concerned, the standard method does produce a fair result when, as usually happens, they invite the taxpayer to put forward a new method. The standard method, after all, is good enough to deal with in-country supplies only unless and until the taxpayer or the Commissioners establish a new method meeting the fair and reasonable test to displace it.
- It is common ground that MBNA's non-EU supplies fall outside the scope of VAT and qualify for recovery. Under the 1994 PESM such supplies produced a residual recovery rate of 11 per cent. No evidence was adduced of the recovery rate they would currently produce under a regulation 103 agreement, but we would not expect it greatly to differ from the earlier recovery figure. Consequently, accepting that MBNA's taxable supplies were (and are) less than 0.01 per cent of its total supplies, we should anticipate a total recovery rate of about 11 or 12 per cent. That figure falls far short of the 24 per cent MBNA claims to be entitled to recover. Against that factual background, and our agreement with the COBE tribunal's decision that the value of supplies to an originator's customers must be included in its calculation of residual input tax, we accept that the Agreed Method did not produce a fair and reasonable attribution. We therefore conclude that the Commissioners could, and did, validly withdraw it.
- By way of postscript, we should perhaps add that we are unable to accept Mr Cordara's submission that the Commissioners could not withdraw the Agreed Method if we were to accept it as a compromise reached on the basis that MBNA was required to bring into account only the value of servicer fees on designated accounts, and there had been no change in its circumstances. That follows both from our conclusion that the Commissioners may withdraw from a PESM or regulation 103 agreement that does not produce a fair and reasonable attribution, and from the Cliff College decision, which we consider to be correct.
- Having concluded that the Agreed Method does not produce a fair and reasonable result, and since the other methods suggested by MBNA all provide for a recovery percentage rate which exceeds that of the Agreed Method, we are also unable to accept that any of them provides for a fair and reasonable attribution of residual input tax.
(1) (b) Should exempt interest and finance charges on designated accounts go into the partial exemption fraction?
- In our judgment, both exempt interest and finance charges on designated accounts constitute part of the total income of a bank such as MBNA. We should therefore expect both to be included in any calculation of total income, i.e. in the denominator of the partial exemption fraction. But that is not necessarily to say that they must be included in that fraction. As we have indicated above, any method of determining residual input tax is concerned with a fair and reasonable attribution, so that their inclusion in or exclusion from the calculation will depend entirely on whether the Commissioners initially, or the tribunal on appeal, are satisfied that that objective is achieved.
(1) (c) Are MBNA's assignments of receivables supplies for VAT purposes so that they should not be included in the partial exemption fraction?
- That was the first of the questions dealt with by the COBE tribunal. But before dealing with it, we note that the COBE tribunal determined that if assignments of receivables were supplies for VAT purposes, there was consideration for them. As we understood him, Mr Paines accepted its decision in that behalf, and we proceed on the basis that he did so, and that it was correct.
- In COBE, the tribunal determined that the company did not make supplies of receivables, as recognised by the Sixth Directive and VATA: the contracts provided for COBE to give security for loans. Alternatively, COBE made supplies only to itself. The tribunal so concluded by each of three processes of reasoning. First, having found (a) that the economic purpose of COBE in making assignments of receivables to the receivables trustee was to enable the trustee to use them as security for borrowings for COBE's benefit, and (b) observed that the receivables trustee and the loan issuer could do only what COBE required of them, it held that the assignments had no economic purpose of their own. The whole purpose of the structure was to enable COBE to raise capital. The tribunal identified what it described as three "telling features" which led it to its first conclusion, namely:
i) the receivables trustee could not do what it liked with the receivables;
ii) during the revolving period, COBE did not wholly alienate the receivables: the receivables trustee could not use monies it received as receivables became collections; and
iii) COBE did not divest itself of all interest in the receivables; they were held in an undivided bare trust in which COBE at all times retained more than a nominal interest.
- Second, even if it were bound to a segmented analysis (which it had rejected in arriving at its first conclusion), the tribunal arrived at the same result: in claiming that there was a true sale of receivables, COBE's witnesses were focusing on what happened if the event occurred requiring notification to cardholders that their accounts had been assigned, i.e. that the equitable assignments had become absolute. Third, the net effect of an assignment before loan notes were issued was that COBE had transferred receivables to itself: a truly bilateral arrangement was lacking, and thus there was no recognisable supply.
- We should mention in passing that Mr Cordara sought to persuade us that there could be supplies of security by MBNA. For that purpose he relied on certain obiter remarks of Chadwick LJ in Trinity Mirror plc v Customs and Excise Commissioners [2001] STC 192 at pages 210 - 211. In rejecting that submission, all that we need say of the remarks is that the learned judge reached no firm conclusion on the point, and in any event, the judgment of the European Court of Justice ("the ECJ") in the case of Kretztechnic AG v Finanzamt Linz (Case C-465/03) [2005] STC 1118 clearly indicates that not to be the case.
- Perhaps not surprisingly, Mr Paines maintained that in coming to its conclusion the COBE tribunal had applied cogent reasoning, whereas Mr Cordara maintained that it had been "beguiled" by Mr Paines into considering the economic effect of assignments of receivables as opposed to their purpose.
- Essentially, Mr Cordara deployed the same case law before us as he did in the COBE case, maintaining that a correct application of it to the facts of that case led to a conclusion opposite to that reached by the tribunal. Even if the COBE tribunal had been correct to hold that the economic purpose of the assignment of receivables was to enable COBE to borrow money, he maintained that the question to be posed in a VAT context still remained: has there been a transaction involving debt? As there was no dispute that, as a matter of English law, there had been an absolute assignment in equity, and since the debts concerned were by nature ephemeral and did not come back, however qualified the alienation may have been, there had been sufficient for Mr Ingram and others properly to give the true sale opinion; MBNA had entered into transactions involving debt which were supplies for VAT purposes. He urged us to look at the transactions involved in the instant case against a background of authorities cautioning against a drift into a broad brush analysis of economic reality (Telewest Communications plc v Customs and Excise Commissioners [2005] STC 481), requiring consideration of how the contracts operated (Tesco plc v Customs and Excise Commissioners [2003] STC 1561), and determining that one could not take an overall, purposive view of a series of transactions in order to ascertain the correct tax consequences (BLP Group plc v Customs and Excise Commissioners (Case C-4/94) [1995] STC 424). As he placed particular reliance on BLP, we find it necessary to look at that case in some detail. BLP sought to recover the input tax on professional fees incurred in selling shares in a German subsidiary company on the basis that they were attributable to its taxable supplies. The ECJ held that the right to deduct under article 17(2) of the Sixth Directive arose only in respect of goods and services which had a direct and immediate link with taxable transactions; the ultimate aim pursued by the taxable person was irrelevant. As the services in question had been used for the purpose of an exempt transaction, BLP was not entitled to deduct the input VAT paid, even if the ultimate purpose of the transaction was the carrying out of a taxable transaction.
- In acknowledging that the services supplied to BLP in connection with the sale of the subsidiary company's shares had been used for the purpose of raising the funds necessary for paying BLP's debts, which derived precisely from the taxable transactions it had effected, the ECJ then rejected its argument that if, in order to meet its liquidity requirements, it had taken out a bank loan, the VAT on the services of an accountant employed in obtaining that loan would have been deductible in full. It held that the principle of fiscal neutrality required that economic decisions should not be influenced by tax factors. The Court further held (at paragraphs 24 and 25):
30. "24. … If BLP's interpretation were accepted, the authorities, when confronted with supplies which, as in the present case, are not objectively linked to taxable transactions, would have to carry out inquiries to determine the intention of the taxable person. Such an obligation would be contrary to the VAT system's objectives of ensuring legal certainty and facilitating application of the tax by having regard, save in exceptional cases, to the objective character of the transaction in question.
31. 25. In that respect, it should be noted that a trader's choice between exempt transactions and taxable transactions may be based on a range of factors, including tax considerations relating to the VAT system. The principle of the neutrality of the VAT, as defined in the case law of the Court [of Justice], does not have the scope attributed to it by BLP. That the common system of VAT ensures that all economic activities, whatever their purpose or results, are taxed in a wholly neutral way, pre-supposes that those activities are themselves subject to VAT."
- Mr Cordara interpreted those passages as confirming that the VAT system was highly transactional, and was concerned with whether a taxpayer had entered into transaction. He maintained that MBNA carried out transactions in the debts, explaining the core of his case as the choice between a borrowing and a securitisation based on an assignment as one between being a pure consumer, or being someone who adopted as a pure consumer a structure which involved a transaction. It was not enough to say that funds had been raised, for that could be said of almost any transaction. One had to be much more precise. He claimed it impossible to construct a coherent set of principles which would hold MBNA's assignments of receivables not to be supplies, while assignments of debts to factors were supplies.
- At paragraph 43 of its judgment in Finanzamt Groß-Gerau v MKG-Kraftfahrzeuge-Factory GmbH (Case C-305/01) [2003] STC 951, a case in which face value was used, the ECJ observed that it was apparent from the court's case law that the concept of exploitation within article 4(2) of the Sixth Directive referred to "all transactions, whatever may be their legal form, by which it is sought to obtain income from the property in question on a continuing basis". That, in Mr Cordara's submission, was a correct description of what MBNA did: it sought to obtain income from the receivables in question on a continuing basis, and dealt with them in a form that was a transaction. Thus something occurred which affected the VAT analysis.
- In further support of MBNA's claim that in assigning receivables it was carrying out transactions which could not be ignored for VAT purposes, Mr Cordara cited paragraphs 27 and 28 of the opinion of the Advocate General (Tizzano) in Customs and Excise Commissioners v Mirror Group plc [2001] STC 1453 where he said:
"27. In order to identify the key features of a contract, however, we must go beyond an abstract or purely formal analysis. It is necessary to find the contract's economic purpose, that is to say, the precise way in which performance satisfies the interests of the parties. In other words, we must identify the element which the legal traditions of various European countries term the cause of the contract and understand as the economic purpose, calculated to realise the parties' respective interests lying at the heart of the contract. In the case of a lease, as noted above, this consists in the transfer by one party of another of an exclusive right to enjoy a movable property for an agreed period.
28. It goes without saying that this purpose is the same for all the parties to the contract and thus determines its content. On the other hand, it has no connection with the subjective reasons which have led each of the parties to enter into the contract, and which obviously are not evident from its terms. I have drawn attention to this point because, in my view, failure to distinguish between the cause of a contract and the motivation of the parties has been the source of misunderstandings, even in the cases under consideration here, and has complicated the task of categorising the contracts at issue".
- In Mr Cordara's submission, the securitisation "machine" was a kind of money raising device which involved a transaction which was an assignment; and that was its economic purpose. In COBE, the tribunal concluded that the economic purpose was to enable COBE to borrow. That was indistinguishable from COBE's motive, and, he maintained, was where the tribunal had erred: it had failed to ask what kind of contractual machinery was then used.
- Securitisation satisfied the interests of the parties in raising money; the contracts clearly did raise money as a pure act of consumption and, in Mr Cordara's submission, there were transactions within the process to enable the money to be raised. He contended that that was confirmed by application of the five principles pointed to by Jonathan Parker LJ at paragraph 159 of his judgment in the Tesco case, namely that:
(1) one had to look at the legal effect of the scheme;
(2) the entirety of the scheme must be examined;
(3) terms contractually agreed might not be determinative of the true nature and effect of the scheme;
(4) economic purpose was not the same as economic effect; and
(5) the economic purpose of the contract is not to be confused with the subjective reasons which may have led the parties to enter into it.
- To those principles, Mr Cordara added the gloss put on them by Arden LJ in her judgment in Telewest Communications plc v Customs and Excise Commissioners [2005] STC 481, where at paragraph 83, she said that there was an objection in principle to taxing transactions according to their economic reality and that the principle of legal certainty was one recognised and applied by the ECJ in the field of VAT. That gloss indicated that the parties knew the content of their contracts and should not be required to make a further economic judgment. Further, he added, in Telewest Communications Arden LJ had made a very important point at paragraph 87 of her judgment in saying that the mere fact that the court sought to find the commercial reality of the transaction did not mean that it would seek to apply the economic reality of the transaction, the economic reality possibly having nothing to do with either the essential features of what the parties agreed or the legal structure of their transaction. He maintained that the commercial reality of a transaction was to find out what really had been agreed; economic reality was something different, and the Court of Appeal in both Tesco and Telewest Communications and the ECJ in Trinity Mirror Group had made plain that one had to take a very cautious path in determining what had been agreed.
- Next, Mr Cordara turned to the case of Lex Services plc v Customs and Excise Commissioners [2004] STC 73, citing it as warning against too much economic analysis at the expense of a detailed contractual transactional analysis. In Lex, the company argued that the economic effect of a scheme it had entered into was similar to a scheme run by a commercial competitor, Hartwell, and produced exactly the same position at the end of the transaction but with Lex paying substantially more VAT than Hartwell. Arden J (as she then was), and subsequently both the Court of Appeal and House of Lords, confirmed that one did not view or analyse transactions on the basis suggested by Lex, but rather by looking at the precise terms of the contract and ignoring the ultimate economic effect. Mr Cordara added that there was a little further guidance on the point from the speech of Lord Walker in the Lord House of Lords (see page 82, paragraphs 27 and following):
"27. The principle of neutrality must however co-exist with the other general principles such as the objective of legal certainty (see BLP). Moreover, the principle does not go so far as to require the transactions which have the same economical business effect should for that reason be treated alike for VAT purposes…. That was made clear by the Court of Justice in Customs and Excise Commissioners v Cantor Fitzgerald International (Case C-108/99) [2001] STC 1453. The Court of Justice stated in para 33:
'The principle of the neutrality of VAT does not mean that a taxable person with a choice between two transactions may choose one of them and avail himself of the effects of the other.'"
- Rhetorically, Mr Cordara asked, who was the lender here? Who could sue MBNA in debt if MBNA did not repay? Where was the interest that MBNA paid that a person could be sued for?
- Mr Cordara then dealt with the case of Customs and Excise Commissioners v Robert Gordon's College [1995] STC 1093 – which involved a sale and lease back arrangement where there was an anti-avoidance provision. In that case Lord Hoffmann observed that VAT proceeded from an ideal image of chains of transactions, and intended to attach to each transaction only so much VAT liability as corresponded to the added value accruing in that transaction, so there was to be deducted from the total amount of tax that that had been occasioned by the preceding link in the chain; as the ECJ emphasised in the BLP case, each transaction in the chain must be examined separately to ascertain objectively what output tax was payable and what input tax was deductible. And, Lord Hoffman opined, at p.1100, the BLP decision "makes it clear that for the purposes of European VAT legislation, it is not permissible to take a global view of a series of transactions in the chain of supply".
- Against the background of the whole of that case law, Mr Cordara submitted that there was clearly a tension between the cases since there were two conflicting lines of authority, that of Robert Gordon's College and BLP suggesting analysis transaction by transaction, and Customs and Excise Commissioners v Pippa-Dee Parties Ltd [1981] STC 495 requiring consideration of the bigger picture. He suggested that they might be reconciled by concluding that the bigger picture was not to be looked at to understand what was going on, but could be considered e.g. to see if there was a self cancelling circular element. In the absence of such an element, Mr Cordara contended that each link in the chain had to be given its own genuine effect.
- Finally, dealing with both first and second routes taken by the COBE tribunal in reaching its decision, Mr Cordara accepted the correctness of a statement in the first sentence of paragraph 110 of that decision that, as a matter of legal form, the loan issuer issued the loan notes and offered its beneficial interest in the receivables trust as security for them. The COBE tribunal continued, "But, as the agreements make perfectly plain, Castle [the receivables trustee] and Carlisle [the loan issuer] were not free agents". Given that the receivables trustee and the loan issuer were under a fiduciary duty to deal with the interest in a certain way, Mr Cordara questioned whether that prevented the assignment occurring. He submitted that, so long as there was an alteration in the beneficial title which was genuine, that was sufficient for a transaction to occur, and thus for an assignment of receivables to be a supply for VAT purposes.
- Having most carefully considered the COBE tribunal's reasons for concluding that assignments of receivables are not supplies for VAT purposes, and taken account of all Mr Cordara's submissions in the instant case, we too hold the assignments to be security for loans, and thus not to be transactions which constitute "true sales". We adopt the reasoning of the COBE tribunal, but would add a number of observations of our own. We should also record that we have taken account of Mr Paines' submissions, but with the single exception of that dealt with at paragraph 151 below, find it unnecessary to rehearse them.
- The deeds by which securitisations are effected are so inter-linked and interdependent as to be incapable of interpretation separately from each other. All are essential if the process is to be successful, and in our judgment their interdependence means that their effect cannot, indeed must not, be considered separately but rather as a whole. So viewed, we have no hesitation in concluding that they deal with loans to MBNA which it has to repay, and do not deal with transactions which are supplies for VAT purposes.
- Mr Cordara's claim that there was complete alienation in assignments of receivables in that the debts were by nature ephemeral and did not come back to the originator was taken up by Mr Paines, who, quite correctly in our judgment, observed that receivables did not vanish without trace, but matured as collections. He submitted, and we accept, that as collections they could not be dealt with by the receivables trustee as it wished, but must be repaid to the originator in exchange for the next batch of receivables. In the ordinary way a true purchaser of receivables would keep the collections, but in the case of securitisations, assuming the originator had not become insolvent in the meantime, he was obliged by the structure of the transactions to repay the collections to the originator. That the majority of the money returned shortly after being received from customers (see paragraph 63 above), and the remainder only at each month end as part of the excess spread was neither here nor there.
- Further, as the Advocate-General (Lenz) observed at paragraph 47 of his opinion in BLP, the objectives of the common system of VAT do not by any means require all forms of raising money to be treated alike, but that operations of the same type are to be treated in the same way. As we explained earlier (see paragraph 136 above), BLP was concerned with the expenses relating to a sale of shares, so that the Advocate-General had to deal with the contrast between such a sale and the taking up of loans. He continued:
32. "The taking up of a loan and the selling of an interest in a company are not, however, operations of the same type for the purposes of the VAT system, because that system focuses on transactions and makes a clear distinction between taxable and exempt transactions. (Nor are they either, moreover, for an undertaking's own resources, whereas the loan is part of its borrowed resources). If a taxable person sells an interest in a company, he is effecting an (independent) transaction within the meaning of the common VAT rules which, being an exempt transaction, excludes deduction of the incident input tax. If, by contrast, he takes up a loan, he does not himself thereby effect a transaction within the meaning of those rules. Instead he is the recipient of a service, which is the subject of a transaction by a third party. Under those circumstances the input tax charged on the advisor services supplied in connection with taking up the loan may be deducted, if it is attributable to taxable transactions." (Emphasis added in the original)
- On that basis, yet again, we are unable to find assignments of receivables to be anything other than loans. The money raised as a result thereof is not part of the undertaking's own resources, but, since it has to be repaid at a later date, is part of its borrowed resources. As the Advocate-General observed, in taking up loans an originator such as MBNA is the recipient of a service, which is the subject of transactions by a third party.
- By analogy the sale of debts to a factor can be compared with assignments of receivables. On the one hand, there is the sale to the factor of the undertaking's own resources and, on the other, receipt of a loan forming part of its borrowed resources. That, it seems to us, is the essential difference between the two means of raising money and it follows that, in the case of assignments of receivables, in taking up loans an originator is not effecting transactions within the meaning of the common VAT rules.
- But, if we are wrong in so holding, we find as a fact that, in the amortisation period, the moneys which CCSE has obtained for MBNA via Deva One Limited (or another loan issuer) from the ultimate investors have to be, and are, repaid by MBNA. In those circumstances, yet again the moneys cannot be considered to be other than loans; thus they cannot be transactions which are supplies for VAT purposes.
- Finally in relation to this question, the quasi-subsidiary status of the receivables trustee established by UK regulatory provision FRS5 would appear to confirm the correctness of the COBE tribunal's holding that the net effect of an assignment before loan notes were issued was that the originator transferred receivables to itself, and thus made no recognisable supply.
(1) (d) Assuming such assignments are supplies, are they and MBNA's of servicing in respect of them to CCSE made outside the European Union, or to a fixed establishment of CCSE in the United Kingdom?
- In the instant case, the Commissioners maintain that the servicing of receivables is made to a fixed establishment of CCSE in the UK, as are assignments of receivables if they are supplies for VAT purposes. Mr Paines so contended on the basis that the place of supplies of assignments was where they were used, and in the instant case, that was at MBNA's UK headquarters in Chester: there were sufficient parallels with the case of Customs and Excise Commissioners v DFDS A/S [1997] STC 388 for us to conclude that Chester was the fixed establishment of CCSE in the UK. He observed that the relationship of MBNA and CCSE was that of creator and creature, and CCSE was, in accounting terms, a quasi-subsidiary of MBNA. MBNA was the dominant party, controlled the SPVs, and had created a structure in which it had given itself the role of servicing and had made its fixed establishment in Chester: that was the establishment at which the receivables were used by CCSE through MBNA's collection agency.
- At paragraph 40 of his opinion in RAL (Channel Islands) Limited and others v Customs and Excise Commissioners (Case 452/03), the Advocate-General (Maduro) observed that problems arise regarding the interpretation of the notion of 'fixed establishment' adding that in Berkholz v Finanzamt Hamburg-Mitte-Aldstadt (Case 168/84) [1985] ECR 2251 the ECJ established the relevant criteria for the interpretation of the concept:
"by stating that a service cannot be deemed to be supplied at a fixed establishment within the meaning of article 9(1) [of the Sixth Directive] unless it presents 'a certain minimum size and both the human and technical resources necessary for the provision of the service are permanently present'".
Having noted that the ECJ "only required the presence of a 'minimum size' of establishment and no more and no less than the resources 'necessary' for the provision of the services of a permanent nature, and that "the Court did not make the permanent presence of all possible human and technical resources, possessed by the supplier himself, in a certain place, a pre-condition for concluding that the supplier has a fixed establishment there", the Advocate-General took the view that that amounted "to the adoption of a minimum-requirement test for characterising a given set of circumstances as constituting a 'fixed establishment' within the meaning of article 9(1), which was subsequently followed and developed by the Court, in particular in ARO Lease BV v Inspecteur der Belastingdienst Grote Ondernemingen Amsterdam (Case C-190/95) and DFDS". He continued:
"42. The ARO Lease case concerned the activity of car leasing to consumers located in Belgium by a Dutch company. The only human presence of the Dutch company in Belgium took the form of independent intermediaries who simply put customers in contact with ARO Lease. Those independent intermediaries had no further involvement in the conclusion or performance of the lease contracts, which were prepared and signed in the Netherlands where ARO Lease had established its business. Furthermore, as the Court noted, the Dutch leasing company did 'not have an officer or any premises on which to store the cars' in Belgium. In that context the Court affirmed that 'when a leasing company does not possess in a Member State either its own staff or a structure which has a sufficient degree of permanence to provide a framework in which agreements may be drawn up or management decisions taken …, it cannot be regarded as having a fixed establishment in that State.
43. The DFDS case follows the same jurisprudential line, although it goes into greater detail on certain points, which I shall consider shortly. In that case a UK subsidiary of a Danish company operated in the UK as a commercial agent for its parent company, selling package tours organised by the latter. The Court considered that the UK subsidiary constituted a fixed establishment of the Danish parent company. In arriving at that conclusion the Court took the view that the fact that 'the premises of the English subsidiary, which has its own legal personality, belong to it and not to DFDS is not sufficient in itself to establish that the subsidiary is in fact independent from DFDS. On the contrary, information in the order for reference, in particular the fact that DFDS's subsidiary is wholly owned by it and as to the various contractual obligations imposed on the subsidiary by its parent, shows that the company established in the United Kingdom merely acts as an auxiliary organ of its parent.' The English subsidiary displayed the features of a 'fixed establishment', following the Berkholz test, to the extent to which it '[was] of the requisite minimum size in terms of necessary human and technical resources'.
44. As the Court expressly affirmed in DFDS, 'consideration of the actual economic situation is a fundamental criterion for the application of the common VAT system'. I am of the opinion that here it is necessary to undertake an analysis that is especially responsive to the factual economic and commercial reality of the case."
And in paragraph 45 of his opinion, the Advocate-General went on to agree with an observation of the Irish Government that "the external perception of customers must play a decisive role" in determining whether a taxpayer had a fixed establishment in a member state.
- Mr Cordara accepted that MBNA met the requirement of having a minimum size with permanent human and technical resources to provide the services. But he maintained that it did operate independently of the supplier because CCSE did not exercise any, or any sufficient, degree of control over it, nor were the services in question supplied from the fixed establishment because CCSE made no supplies in the United Kingdom; in particular it made no supplies through the agency of MBNA.
- He submitted that the place where banking and financial services were supplied when the person to whom they were supplied was established outside the European Community was the place where the customer had established his business or had a fixed establishment to which the service was supplied (see article 9.2(e) of the Sixth Directive). In the instant case, the supplies of credit card debts were made to CCSE in Jersey because that was where it had established its business: it had no fixed establishment in the UK to which supplies could be made. He added that, in any event, it would be highly artificial to come to the conclusion that MBNA was making sales of credit card debts to itself at a fixed establishment of CCSE.
- When considering where supplies were made, the primary point of reference was the place were the supplier had established its business: see article 9.1 of the Sixth Directive and paragraph 17 of the ECJ judgment in Berkholz. Mr Cordara submitted that that point of reference was to be departed from only where it did not lead to a rational result for tax purposes or lead to a conflict with another member state; and there was no reason to depart from the primary point of reference in the instant case.
- CCSE's position was analogous to that of any other investor. Case law indicated that the mere acquisition of financial holdings in other undertakings, such as the holding of shares, without involvement in their management, was not an economic activity for VAT purposes, see e.g. Polysar Investments Netherlands BV v Inspecteur der Invoerrechten en Accijnzen te Arnhem (Case C-60/90) [1991] ECR I-3111. In Mr Cordara's submission, CCSE's position was that of such an investor, and MBNA, by servicing the credit card debts it had sold to CCSE, was maintaining the value of CCSE's investment. That was a supply located outside the European Community, and was thus outside the scope of VAT with recovery.
- In the COBE case, the tribunal concluded that, assuming the assignment of receivables by the originator, COBE, were supplies for VAT purposes, they were made outside the European Union as was the servicing of them by the receivables trustee. We agree with the COBE tribunal that traders nowadays commonly outsource tasks to others, and may well do so across national borders; it does not follow that an organisation to which a task has been outsourced for that reason, becomes a fixed establishment of its customer. The perception to which Advocate-General Maduro referred at paragraph 45 of his opinion in RAL in the instant case is that of the loan issuers: they deal with CCSE in Jersey. Assuming assignments of receivables are supplies for VAT purposes, we conclude that they and the servicing of them are supplies made outside the European Community.
(2) The Assessments
(2)(a) Has MBNA discharged the burden of showing that less tax is due from it than that assessed, and showing what the amount of tax properly due from or repayable to it is?
- Mr Cordara submitted that the correct amount of tax due from MBNA was that yielded by the calculations it made following withdrawal of the Agreed Method. Mr Paines rejected that approach as not being in accordance with regulation 103 for it did not attribute residual input tax to specified supplies in accordance with the relative extent of use of inputs as required. It was logically flawed in that, whilst using values of outputs as an indication of the use of inputs:
(1) the calculations continued wrongly to omit the value of exempt supplies to designated cardholders, which were a relevant output; and
(2) the calculations included the amount of the servicer fees payable to MBNA under the terms of the RTDSA.
- Alternatively, Mr Cordara contended that the correct approach would have been to use the Agreed Method with adjustments to include the value of exempt supplies to designated cardholders in the denominator and 'the value of the sales of future finance charge receivables' in both the numerator and denominator. Mr Paines maintained that that too was wrong both because the calculations included the amount of the servicer fee payable to MBNA, and because assignments of receivables were not specified supplies, and their inclusion would in any event be distortive.
- The contractual fee for servicing should not be included in the regulation 103 calculation in Mr Paines' further submission. He explained the issue under regulation 103 to be the extent to which inputs were used by MBNA, and accepted that an approach based on the value of outputs was legitimate in so far as the value of an output was a valid measure of the comparative use of inputs in making it. Where it was contended that a particular output value should be included in a values-based fraction, the question arose whether the inclusion of that value was conducive to accurately measuring the relative extent of use of inputs.
- MBNA incurred residual input tax that it could not attribute directly to taxable supplies, exempt supplies or specified supplies. It was common ground that those inputs were in part used in running MBNA's credit card and personal loan businesses, and thus in making exempt supplies. (MBNA did, however, dispute that they were so used in relation to designated credit card accounts). On that basis, Mr Paines maintained that MBNA's contention must be that the fraction should include the servicer fee in order to reflect the extent of use of residual inputs in making specified supplies of servicing pursuant to the RTDSA. He submitted that that argument appeared to involve a misconception as to the extent of the activity that amounted to performance of the servicer transaction under the RTDSA. MBNA's evidence indicated a belief that the whole of the activity of managing a designated account was a supply of servicing pursuant to the RTDSA. But, on a proper construction of that document, Mr Paines claimed the servicing activity to be limited to (a) servicing, administering and collecting the receivables pursuant to the first part of clause 9.1 of the RTDSA, and (b) giving advice and making reports to the receivables trustee and the other activities referred to in the remaining sub-clauses of clause 9. He maintained that the activities summarised at (a) related to receivables (being existing cardholder debts) and by definition were activities relating to cardholder debts that existed. Activities undertaken prior to receivables coming into existence, e.g. soliciting credit card customers, issuing credit cards to them, or authorising their purchases, could not, he claimed, be said to amount to servicing, administering or collecting any receivables, nor could activities such as arranging payments to merchants.
- Although the costs of collecting the debts of a business were among its inputs, the management of a credit card business involved a wider range of activities, inevitably using more consumption of inputs than the activity of servicing, administering and collecting receivables as described in the first part of clause 9.1. Accordingly, in Mr Paines' submission, many of the account management activities claimed by MBNA could be related to its credit card business, but not to servicing the receivables within the scope of the RTDSA.
- Mr Paines contended that it was wrong to include the contractual servicer fee in the apportionment calculation under regulation 103 for a number of reasons. The evidence showed that MBNA administered designated accounts in precisely the same way as non–designated accounts: its staff did not know which of its accounts had been designated. The levels of costs were common to both types of account, and the same must be true of that subset of account management activities that amounted to servicing, administering and collecting receivables. Where MBNA used a portion of its residual inputs in operating a non-designated account (including dealing with the cardholder's debt), that portion was used in making supplies of credit; and since MBNA included the value of exempt supplies to holders of non-designated accounts in the fraction, it appeared to accept that. But it operated designated accounts in exactly the same way, and therefore used residual inputs in the same way and to the same extent in operating both types of account. Likewise, the servicing, administering and collecting cardholder's debts used inputs in exactly the same way and to the same extent whether or not the account had been designated. MBNA made exempt supplies of credit to holders of designated accounts, and used inputs in doing so. That was why, in Mr Paines' further submission, the value of exempt supplies to those cardholders must be included in the fraction; and it was also relevant to an analysis of the relative extent of use of residual inputs in servicing.
- Further, because the costs of collecting the debts of a business were inputs of it, so the costs of collecting credit card debts were inputs of a credit card business – as MBNA accepted in the case of that part of its credit card business not involving designated accounts. Since, in Mr Paines' submission, MBNA was wrong to dispute that it also made exempt supplies to holders of designated accounts and used inputs in doing so, it followed that the portion of residual inputs used in collecting those cardholders' payments was still being used in the credit card business. The fact that MBNA had undertaken in the RTDSA that it would service, administer and collect the receivables on the designated accounts did not mean that MBNA was using its residual inputs to any lesser extent in the credit card business when it did so than when it dealt identically with a non-designated account.
- The fact that MBNA received a fee (funded in part by itself as transferor beneficiary) in return for continuing to conduct part of the management of its credit card business did not alter the fact that the inputs were still being used to conduct the same part of the management of its credit card business. The existence of the servicer function could logically impact on the relative use of residual inputs only to the extent that the function involved using inputs in activities additional to those already necessarily undertaken in the credit card business.
- Mr Paines maintained that the servicer fee was an unreliable guide to the use of inputs. He accepted that the part of the servicing function consisting of giving evidence and making reports to the receivables trustee involved work (and thus the incurring of inputs) additional to that which MBNA did in the course of its consumer credit business. But, he said, the servicer fee, payable in respect of the whole of the servicer activity, could not be a reliable measure of the extent of use of residual inputs in that part of the servicer activity. Moreover, the level of the servicer fee was not governed by normal commercial factors. It was provided for in an agreement between MBNA on the one hand and the receivables trustee and the investor beneficiaries on the other, those in the latter category having been found to be creatures of the originator of a securitisation by the COBE tribunal (see paragraph 66 of its decision).
- A large part of the administration of cardholder accounts appeared to have been outsourced by MBNA to Experian; and all of the reporting side of servicing had been outsourced to MBNA Corporation in the USA. Experian's fees were exempt from VAT and also substantially lower than provided for in the RTDSA.
- Mr Paines acknowledged that it was not improper for the servicing fees to be set at whatever level the originator desired. They had been set at significantly different levels in different series of MBNA securitisations, and under clause 9.1(e) of the RTDSA, MBNA could elect to receive a reduced or increased servicer fee. In Mr Paines' submission that reflected the fact that the servicer fee was funded from money that would have returned to MBNA in any event; and a sum payable to MBNA out of money which was already its property could not be part of the consideration.
- Even to the extent that the servicer fee was derived from other money in the trust, the level at which the fee was set did not affect the overall amount of money that returned to MBNA from the receivables trustee. That was because MBNA was, in any event, entitled to receive the excess spread (described in paragraph 51 of the COBE decision as the surplus of income receipts after the outgoings of the trust, including the servicer fee, had been paid). Mr Paines claimed that it followed that, were the servicer fee higher, the excess spread would be correspondingly lower, and, were the servicer fee lower, the excess spread could be correspondingly higher: but the aggregate amount received by MBNA would remain the same.
- The assessments were made by the Commissioners on the basis that MBNA was entitled to recover no residual input tax under regulation 103. We are unable to accept that that was the case. As we indicated at paragraph 127 above, it is common ground that non-EU usage of credit cards is outside the scope of VAT, but with recovery. Non-EU interchange has a similar status. In our judgment, those items should be aggregated to form the numerator of the regulation 103 fraction.
- Alternatively, notwithstanding that regulation 103 itself contains no provision for a proxy for usage, we see no reason why, if it were to produce a higher recovery rate and MBNA were to choose to use such a proxy, the numerator in the regulation 103 fraction should not consist of the aggregate of the values of non-EU credit card usage and non-EU interchange.
- We earlier held assignments of receivables not to be supplies for VAT purposes (in paragraphs 149 to 156 above), and we shall shortly go on to hold that the designation of MBNA's customers' accounts has no effect on the sum of residual inputs (in paragraph 194 below). Consequently, only the latter item is to be included in MBNA's regulation 103 fraction.
- We agree with Mr Paines that the value of exempt supplies to designated cardholders should be included in the denominator of the fraction, they being relevant outputs and thus part of its total supplies.
- In the light of the contents of the last four immediately preceding paragraphs, in the expectation that by the 21st day after the release date of our decision, MBNA will have been able to supply the Commissioners with any information they lack for the purpose, we direct the Commissioners within 42 days of the release date to calculate the residual input tax to which MBNA is entitled under regulation 103 in each of the accounting periods for which it has been assessed to tax; and we reduce the assessments by the resulting figures. To that limited extent, we allow MBNA's appeal against the assessments.
- If MBNA is unable to accept the Commissioners' calculations for any reason, it shall be at liberty within 42 days of the release of our decision, to apply for further directions to enable us to deal with the matter.
- For completeness, we should add that we are satisfied that the assessments were made to the Commissioners' best judgment as required by section 73 of VATA.
- Before ending this section of our decision, we should perhaps deal with a submission by Mr Cordara, which he claimed to be based on the ECJ judgment in MKG, that a taxpayer servicing its own debts was providing a service for VAT purposes. We are unable to find any reference in the judgment to such a proposition, and we reject it.
(2)(b) Does the servicing of customers' accounts use residual inputs?
- As we mentioned earlier, in 1994 MBNA entered into a PESM with the Commissioners. It provided for the recovery of residual input tax based on non-EU usage of credit cards as a proportion of all uses of credit cards by cardholders, and produced a recovery rate of about 11 per cent. Mr Paines contended that that method was not a good measure of the use of MBNA's inputs: absent securitisation, the true recovery proportion of a business whose taxable supplies were less than one thousandth of its total supplies, as in MBNA's case, should be very low indeed. Yet the impact of securitisation – where nothing changed in MBNA's behaviour (it continued to supply credit facilities to cardholders and to supply intermediary services for merchants in return for interchange) or in the way it consumed inputs (it continued to service all cardholders' accounts but obtained payment for the service of designated accounts from the receivables trustee) – as advanced by Mr Cordara, appeared to increase its recovery proportion quite dramatically, to some 25 per cent on the Commissioners' own interpretation of the Agreed Method.
- Mr Paines explained that a situation such as the impact of securitisation coupled with a servicing obligation on the originator was not one covered by any authority: it was virgin territory. He observed that cases such as Customs and Excise Commissioners v Telemed Limited [1992] STC 89 and Customs and Excise Commissioners v Redrow Group plc [1999] STC 161 were similar to the instant case, but not quite like it. (Those other cases involved a situation where a taxpayer did something which simultaneously benefited two people, but only one of them paid him. In each it was held that, for VAT purposes, a supply of services was made to the payer).
- The question to be answered was formulated by Mr Paines in this way: where a second person, in this case the receivables trustee, starts paying a taxpayer to continue making supplies to an existing customer, identically as before, are the inputs used in making the supply to the existing customer deflected in whole or in part into being inputs of fulfilling the taxpayer's promise to the second person?
- Because a supply of services was defined in section 5 of VATA as a supply made for consideration, there could be a supply only to a person providing consideration. Thus the answer to the question, as suggested by Mr Paines, was that the inputs were not so deflected both because of the nature of the provision and the supply that was made to the second person. What MBNA promised and what it supplied to CCSE, as receivables trustee, when it carried out its provision was continuing to consume inputs in the pre-existing business of supplying the first customer: its promise was "I will go on servicing the customer as before", and implicit in it was, "I will go on consuming inputs in servicing the cardholder in the same way as before".
- He submitted that it was an error in analysis to suggest that, following securitisation, inputs were being used in any different way than before securitisation. If a correct analysis were that MBNA continued its consumer credit business and continued incurring inputs in that business, then the inputs remained consumed in that business despite the new promise, and thus there was no opportunity for saying that they were attributable to any extent to the new promise and the performance of it.
- Of a suggestion by Mr Cordara that an activity such as sending a bill to a cardholder was not in itself an act of supply to the cardholder, but a supply to the receivables trustee, Mr Paines observed that the act of supply took place when the cardholder used his credit card. In his submission to suggest that the bill was relevant involved slipping into the fallacy that inputs were attributable to supplies only if they were consumed in an act of supply, that being the test in article 17 of the Sixth Directive. He submitted that inputs consumed in sending a bill were inputs of the business with the customer that had generated the bill: ergo, the expenses were the expenses of the credit card business. And even in the case of transactors, there was a supply by MBNA to the merchant in return for interchange.
- Mr Cordara claimed that everything MBNA did, including its advertising, was related to securitisation because it stimulated the use of credit cards to generate receivables. If that line of argument was permissible, Mr Paines maintained that everything MBNA did stimulated the use of credit cards and the performance of services generated interchange, which went into the trust.
- Mr Paines submitted that Mr Cordara's claim that MBNA supplied credit to cardholders in order to generate receivables to fuel the supply to the receivables trustee was completely opposite to the true position, namely that securitisation was carried out to generate the raw material, i.e. the capital, to fuel MBNA's consumer credit business. As MBNA said in its annual report: "The principal activity of the group is personal lending and ancillary activities in the UK, Ireland and Spain". Securitisation could thus only be regarded by MBNA as amongst its ancillary activities. Mr Cordara rejected that interpretation as "classic Dial-a-Phone heresy" (Dial-a-Phone v Customs and Excise Commissioners [2004] STC 987: it represented an incomplete and totally inadequate analysis of what MBNA did). The facts in Dial-a-Phone were that a company made taxable supplies of mobile telephones to customers and also made exempt supplies of services as insurance intermediary to an insurance company in the case of customers taking insurance cover. The Court of Appeal held that only a proportion of its input tax on advertising and marketing costs was deductible against VAT charged by the company to its customers.
- In summary, Mr Paines submitted that the residual inputs consumed in MBNA's call centre and elsewhere in Chester remained cost components of the supply of consumer credit in the case of a designated cardholder as much as a non-designated cardholder; and the existence of the promise to service, whether that word were widely or narrowly interpreted, was no more than a promise to incur those cost components in the consumer credit business, and did not deflect the use of those cost components as MBNA contended.
- We reject Mr Cordara's allegation that to describe MBNA's business as that of personal lending and ancillary activities is "classic Dial-a-Phone heresy": in our judgment, the description represents a completely accurate and comprehensive summary of what MBNA does.
- Apart from being unable to accept Mr Paines' claim that MBNA's recovery rate under regulation 103 must be "very low indeed", we accept his submissions and adopt his reasoning. In our judgment, the inputs used in making supplies to an existing customer are not deflected into being inputs of fulfilling MBNA's promise to CCSE. We therefore hold that the designation of MBNA's customers' accounts has no effect on the use of residual inputs.
(2) (c) Assuming that the servicing of customers' accounts uses residual inputs, should that be reflected in the partial exemption fraction using the full servicer fees payable under the RTDSA or some lesser proportion?
- Mr Paines maintained that since a portion of the servicer fees due to MBNA amounted to its paying itself, that portion could not be consideration or part consideration for the purposes of the partial exemption fraction. As the supplement to the RTDSA provided (at Part 4 paragraph 9.2(i)(1)):
"The transferor beneficiary will pay the transferor servicing fee amount as part of the consideration for the grant of the transferor interest".
- Thus, he explained, where MBNA was the transferor and the servicer, a proportion of the servicer fees was payable by itself in one capacity to itself in another, and that proportion was determined negatively in the shape of whatever was not to be paid by the investor beneficiaries. What the supplement provided for was that liability for the servicer fees was determined in the ratio the transferor interest bore to the investor beneficiary interest in the pool of receivables. Mr Paines contended that the transferor servicing fee amount could not be consideration for the servicing when the consideration was paid by the same person as received it.
- On a true construction of the RTDSA, servicing was something less than the whole activity of managing a cardholder's account: clause 9(1)(b) of the RTDSA explained its scope as extending only to servicing and administering the receivables. Mr Paines maintained that there was in the documents a wider obligation undertaken by MBNA as transferor which was not undertaken in consideration of the servicer fee. As the covenant at paragraph 1.3 of Schedule 7 to the deed explained:
"1. The Transferor shall …
1.3 comply with and perform its obligations under the Credit Card Agreements relating to the Designated Accounts and the Credit Card Guidelines and all applicable rules and regulations of MasterCard International Inc. and its subsidiaries, if any, and VISA International, Inc. and its subsidiaries, if any, except insofar as any failure to comply or perform would not have a Material Adverse Effect".
- Mr Paines observed that that clause contained an obligation on MBNA to continue granting credit to process payments to merchants vis-à-vis the receivables trustee. But it was separate from the servicing obligations, and MBNA was not remunerated by the servicer fee. He contended that if the parties to the deeds had intended that the performance of all MBNA's obligations to credit cardholders should be part of servicing, they would have so provided in the RTDSA.
- The servicer function, although carried out by MBNA, was a function the deeds envisaged as being capable of taken over by a "successor servicer", in MBNA's case by Deutsche. But the successor servicer agreement did not contain an obligation by the successor servicer to accept an obligation to honour the credit card agreements. That wider obligation was one of the transferor and was why it was included in the transferor's covenants in Schedule 7 to the Master Framework Agreement of 31 October 2001 and not in the servicer agreement: it always remained with the transferor. Consequently, Mr Paines maintained that we need not imply any obligation on MBNA to continue granting credit. Assuming we were to accept his submissions, Mr Paines explained the consequence of the analysis as expressed above.
- He submitted that it was incorrect to include the whole of the servicer fee in the numerator of the partial exemption fraction, though residual inputs were consumed at the same rate in servicing as in account management, when the true position was that only a small portion of the inputs consumed in account management were also consumed in account management that amounted to servicing.
- Mr Cordara did not deal with Mr Paines' submissions in detail, but merely reiterated that since assignments of receivables were supplies for VAT purposes, the answer to the question must be that the full servicer fees payable under the RTDSA should be included in the partial exemption fraction.
- Again, for the reasons advanced by Mr Paines, we are unable to agree that the full servicer fees should be so included. In our judgment, that portion of the servicer fees determined negatively in the shape of whatever is not to be paid by the investor beneficiaries should not be included in the partial exemption fraction.
(2)(d) How should the servicer agreement be construed as to its scope, and the administering and collecting of receivables within the meaning of clause 9.1 thereof?
- On the basis of the superficial evidence adduced, we are unable to answer this question. If the parties still require an answer, a further hearing will be necessary. We direct that either party shall, within 42 days of the release date of our decision, be at liberty to apply for directions for such further hearing.
(2)(e) When used as a proxy, does the servicer fee suffer from the further flaw of being unreliable, not being an arm's length value?
- In relation to this question, MBNA adduced certain evidence relating to its acquisition of books of credit card debts from Alliance & Leicester plc and Co-operative Bank plc confirming that those companies had agreed to continue servicing the accounts following their acquisition. It also adduced evidence of arrangements it had both with Experian and MBNA America in the USA whereunder those companies also provided services to MBNA to support its claim as to the reasonableness of the servicer fees included in the calculations it had submitted to the Commissioners and which they had rejected.
- It is plain from the evidence before us that, subject to satisfying the ultimate investors that the servicer fees do not reduce the interest rating of their coupons, and do not exceed that acceptable to the money markets as a whole, MBNA has the ability to determine those fees for if they are not paid to it as part of the waterfall they return to it as part of the excess spread. However, since the investors would not tolerate fees that were not commensurate with current market rates, we are satisfied that the rates in fact charged are reliable, notwithstanding that they could be said not to be an arm's length. The only possible restriction on its ability freely to determine the fee level is that that might be imposed by the investors in the bonds being unwilling to take them up.
(3) The Voluntary Disclosure
(3)(a) What is the correct construction of the phrase "at that particular time" at paragraph 3(b) of the Agreed Method?
- In relation to the voluntary disclosure, the dispute between the parties centres on paragraph 3(b) of the Agreed Method which, for convenience, we here repeat. It reads:
"In calculating the proportion [of residual input tax recoverable] under paragraph 2(a) above, there shall be excluded … any sum receivable from –
(b) cardholders whose account is, at that particular time, the subject of securitisation arrangements …"
- The issue turns on the meaning of the phrase "at that particular time". Mr Paines submitted that, read in context, those words were inserted in order to emphasise that the inclusion in or exclusion from the calculations of an amount was governed by the status of the cardholder's account (designated or not designated) in the period for which the calculation was done: it was intended to re-inforce the point that the subsequent securitisation of the account did not alter the way in which it was to be treated in the return. On that construction, he maintained, MBNA was able to know which amounts to include in and which to exclude from the calculation it had to make each month.
- Mr Paines observed that MBNA's representatives, PWC, never queried the meaning of paragraph 3(b) of the Agreed Method and proceeded to operate it in accordance with the interpretation propounded in the last preceding paragraph until the change of view communicated in their letter of 31 July 2003 accompanying the voluntary disclosure. He submitted that the approach adopted in that letter – that the Agreed Method entitled MBNA to exclude interest and finance charges which, at the time they arose, related to a non-designated account but which was securitised at some later date prior to payment by the cardholder – was inconsistent with the terms of the Agreed Method. In particular, he maintained, that approach gave the phrase 'at that particular time' the meaning of 'at any time prior to payment', and that was not, in Mr Paines' further submission as a matter of language, a meaning that the words could bear. Further, paragraph 3(b) referred to "any sum receivable" and not "any sum received", the relevance of which was, as he explained, that, in the context of securitisations of receivables, there was a difference between amounts owed to a business (receivables) and amounts paid to or received by it (collections).
- Moreover, he claimed, MBNA's new interpretation of the Agreed Method made it incapable of operation – a result which the parties could not have intended. MBNA had a monthly accounting period and an obligation to submit a VAT return within a month of the end of each accounting period. Thus its return for (say) January had to be made by the end of February. On the Commissioners' interpretation of the Agreed Method, MBNA was able to make its monthly return for January by ascertaining what interest or charges arose on accounts in the month and whether the account was designated or not. On MBNA's new interpretation, securitisation of the account in any later month – even after the return had been submitted – would with hindsight require the exclusion of the interest or charges from the partial exemption fraction if the interest or charges had not been paid in the meantime. On that approach, the information would not be available to allow the required calculation to be done at the date by which it had to be done.
- The explanatory notes in appendix 5 to the voluntary disclosure appeared to confirm that MBNA did not, at the time it agreed the Agreed Method, have the information required to make the calculations it contended the Agreed Method envisaged. The notes said that "the income which is to be excluded from the method calculations was not historically reported on a monthly basis". Mr Paines submitted that MBNA would not have agreed a method which it was not in a position to operate: the agreement it made must have been intended to operate as interpreted by the Commissioners and, for some three years, by MBNA.
- In contrast, Mr Cordara maintained that, on the true meaning and intendment of the Agreed Method, income from designated accounts was not to be included in the turnover fraction for which it provided. That meant that when income was received from a non-designated account, it was to be treated as exempt income of MBNA, whereas when income was received from a designated account, it was to be excluded from the calculation. For that reason, and in any event by reason of regulation 90 of the Regulations (continuous supplies of services), unpaid consideration was not to be included in the calculation since no supply occurred until payment. Even if that were not so, any input tax calculation based wholly or in part on unpaid consideration would have to be revisited either in any subsequent period when the "paid position" had been established and / or at the stage of the annual adjustment, or otherwise, in order to establish the correct final attribution of the input tax in question. He maintained that, unless that were so, the proper operation of the Agreed Method could be undermined since it was its clear intention that income from designated accounts would not operate to block or reduce MBNA's input tax recovery. That did not reflect the agreement made.
- Apart from the fact that MBNA operated the Agreed Method from its inception until it was withdrawn by the Commissioners as they contend it should have been operated, we are unable to accept the interpretation of it contended for by Mr Cordara. In our judgment, as suggested by and for the reasons advanced by Mr Paines, the Agreed Method should be interpreted as excluding from the calculation sums receivable from cardholders whose accounts were designated at the time at which the sums became receivables. We might add that the supplies of credit, which are throughout made by MBNA, are made only on each occasion the cardholder uses his card: they are not continuous, so that regulation 90 is, in our judgment, irrelevant in the instant case. The availability of credit is different from a supply of credit.
(3)(b) Is the voluntary disclosure out of time by reason of regulation 29(1A) of the Regulations in respect of the periods April and May 2000?
- The Commissioners' primary case in relation to this question, as explained by Mr Mantle, was that MBNA's input claims in the voluntary disclosure for April and May 2000 had no substance. Their secondary case was that the claims for those two months were time barred by regulation 29 of the Regulations, having been submitted on 31 July 2003. The relevant parts of that regulation are sub-paragraphs (1) and (1A). They read as follows:
"(1) ... and save as the Commissioners may otherwise allow or direct either generally or specially, a person claiming deduction of input tax under section 25(2) of the Act shall do so on a return made by him for the prescribed accounting period in which the VAT became chargeable.
(1A) The Commissioners shall not allow or direct a person to make any claim for deduction of input tax in terms such that the deduction would fall to be claimed more than 3 years after the date by which the return for the prescribed accounting period in which the VAT became chargeable is required to be made."
- Section 25(2) of VATA provides that a taxpayer "is entitled at the end of each accounting period to credit for so much of his input tax as is allowable under section 26, and there to deduct that amount from any output tax that is due from him". (Section 26 deals with input tax allowable under section 25.)
- Mr Mantle claimed that regulation 29 raised five points, namely:
(1) whether there was a claim made under regulation 29;
(2) that the voluntary disclosure claim was one made under regulation 29;
(3) that regulation 29 claims were subject to the time limit provided by regulation 29 (1A);
(4) what that time limit was; and
(5) that part of the voluntary disclosure claim was out of time for April and May 2000 when that time limit was applied to it.
- In relation to (1), Mr Mantle observed that PWC by letter of 22 October 2003 confirmed that the claim was made under regulation 29. In relation to (3) and (4), he maintained, and Mr Cordara accepted, that regulation 29(1A) contained the following three step process:
(1) the prescribed accounting period in which the VAT became chargeable had to be identified;
(2) the date by which the return for that period was required to be made had also to be identified; and
(3) it had to be decided whether the claim to deduct input tax was made more than three years after that date.
- MBNA was required to make its claim (monthly) period by period. It then had to make an annual adjustment, which resulted in the total adjusted figure. MBNA's annual adjustment year ran from 1 April to the following 31 March. Therefore its annual adjustment had to be made in its April return. Mr Mantle explained the annual adjustment as requiring a recalculation at the end of its annual adjustment year using the figures included in the monthly returns for that year, i.e. aggregation using the existing figures from monthly returns and not introducing new ones. And when a PESM / regulation 103 agreement was in place, that method / agreement must be used in every respect. There was no room for recalculation. If something more complicated than the use of existing figures were required in making an adjustment, specific provision would be made for it in the Agreed Method. And the fact that there was provision for an annual adjustment did not permit MBNA to claim that input tax that became chargeable in April and May 2000 and was not claimed could be claimed in a later period.
- MBNA claimed in its voluntary disclosure that a sum of £139 million interest should be excluded from the calculation of residual input tax as having been charged in the year before accounts were designated and paid after they were designated. Based on the figures in MBNA's accounts, the figure of £139 million represented 67 per cent of its exempt income for the adjustment year to March 2004.
- Mr Cordara contended that MBNA had identified the input tax, and had fed it into the calculation as it believed that had to be done. Thus all its inputs had been the subject of a claim within the first relevant period. But, he maintained, assuming MBNA to be correct on the interpretation of paragraph 3(b) of the Agreed Method, the percentage initially applied had been the wrong one. That was due either to MBNA being correct on the interpretation point, or, if not, because the annual adjustment provision required the turnover figures to be calculated by reference to the actual dates of receipt, and for the necessary adjustments to be made at the end of its adjustment year.
- To achieve the objects of article 17(5) of the Sixth Directive inputs had to be linked to outputs in a fair and reasonable way, i.e. on the basis of an annual adjustment to the figures for the whole tax year. Mr Cordara contended that it would be ludicrous to carry out that exercise when all the money came in and the time of supply was crystallised only after an account was securitised. Therefore regulation 90 had to be realistically applied, and its application required that it be done by reference to the first date on which the money became a receivable.
- Secondly, Mr Cordara contended that the first date on which money became a receivable was the date from which, according to the Agreed Method, the three-year capping period commenced, and it mattered not whether the voluntary declaration purported to be an annual adjustment. Since MBNA submitted the declaration before the third anniversary of the first adjustment date, its input tax claim was made timeously.
- Thirdly, if there was an error, then the matter should be considered an "error-correction situation". Either there was an error, or there was not. If there was no error, MBNA was simply operating the Agreed Method: the claim was made within three years of the first annual adjustment date. If there was an error, then Mr Cordara claimed that the situation was governed by the error-correction procedure provided for by regulation 35 of the Regulations. He relied on the following observations of Stanley Burnton J at paragraph 51 in R (on the application of Cardiff County Council) v Customs and Excise Commissioners [2002] STC 1318:
"I would add that the wording of Regulation 35 requiring correction of a return within such time as the Commissioners may require is more appropriate to the requirement that errors be corrected than a prohibition of late corrections".
- (Errors and mistakes are dealt with by regulation 35 of the Regulations in the following terms:
"Where a taxable person has made an error—
(a) in accounting for VAT, or
(b) in any return made by him,
then, unless he corrects that error in accordance with regulation 34, he shall correct it in such manner and within such time as the Commissioners may require.")
- Mr Mantle rejected that submission relying on the decision of the President of these tribunals, His Honour Stephen Oliver QC, in Greenpeace v Customs and Excise Commissioners (2000), Decision No. 16681, where at paragraph 18 he concluded that an annual adjustment provision did not allow for error correction.
- We agree with Mr Mantle that the annual adjustment provision does not allow for error correction; and having earlier decided that MBNA's supplies of credit are made when a cardholder uses his credit card, and that it does not make continuous supplies, we repeat that in our judgment regulation 90 is irrelevant in the instant case. Consequently, the error-correction procedure of regulation 35 does not come into play.
- The annual adjustment required MBNA to recalculate its entitlement to recover residual input tax under the Agreed Method using nothing but the figures in its monthly returns in the annual adjustment year, i.e. not introducing new figures. Whether viewed from the Commissioners' primary or secondary position, we hold that MBNA's input tax claims for April and May 2000, as included in its voluntary disclosure, were made out of time.
Conclusion
- To the very limited extent we have indicated in relation to MBNA's appeal against the tax assessments, we allow the appeal. We dismiss its appeal against the withdrawal of the Agreed Method and its claim under the voluntary disclosure.
- Mr Paines made application for the Commissioners' costs in the event of our dismissing the appeal. We accede to his request to the extent of nine-tenths of their costs of and incidental to and consequent upon the appeal. We do so on the basis that we have decided that MBNA is entitled to recover approximately one-tenth of the tax at issue in the appeal. In the event of the parties being unable to agree the costs in question, we direct that they are to be the subject of detailed assessment in accordance with Part 47 of the Civil Procedure Rules by a master or district judge of the High Court.
DAVID DEMACK
CHAIRMAN
Re-release Date: 5 January 2006
MAN/03/0523
APPENDIX I
| COBE |
MBNA |
|
COBE |
MBNA |
| 8 |
23 |
|
40 |
56 |
| 9 |
24 |
|
42 |
57 |
| 10 |
25 |
|
43 |
58 |
| 11 |
26 |
|
44 |
59 |
| 12 |
27 |
|
45 |
60 |
| 13 |
28 |
|
46 |
62 |
| 14 |
29 |
|
47 |
63 |
| 15 |
30 |
|
48 |
64 |
| 16 |
31 |
|
49 |
65 |
| 17 |
32 |
|
50 |
66 |
| 18 |
33 |
|
51 |
67 |
| 19 |
34 |
|
52 |
68 |
| 21 |
36 |
|
53 |
69 |
| 22 |
38 |
|
54 |
70 |
| 23 |
39 |
|
55 |
71 |
| 24 |
40 |
|
56 |
72 |
| 26 |
42 |
|
57 |
73 |
| 27 |
43 |
|
58 |
74 |
| 28 |
44 |
|
59 |
75 |
| 29 |
45 |
|
60 |
77 |
| 30 |
46 |
|
61 |
78 |
| 31 |
47 |
|
62 |
79 |
| 32 |
48 |
|
63 |
80 |
| 33 |
49 |
|
64 |
81 |
| 34 |
50 |
|
65 |
82 |
| 35 |
51 |
|
66 |
83 |
| 36 |
52 |
|
|
|
| 37 |
53 |
|
|
|
| 38 |
54 |
|
|
|
| 39 |
55 |
|
|
|
