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HMRC internal manual

VAT Finance Manual

HM Revenue & Customs
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Money (including transfer of money) and related services: foreign exchange (forex): supply and liability

There have been three cases that directly affect the way HMRC policy deals with forex. These are Republic National Bank of New York (“RNB” - tribunal decision 7894), The First National Bank of Chicago (“FNBC” - Case C-172/96 ([1998] STC 850)) and Willis Pension Trustees Ltd (“Willis” - tribunal decision 19183).

Republic National Bank of New York

RNB was the first challenge to the Department’s previous ‘no supply’ position on forex activities. The Tribunal took the view that not only was there the provision of a foreign exchange facility but also the provision and delivery of “clean” bank notes for which customers paid a premium over the “screen” price and that therefore there was a supply. The Department took the view that this decision could be confined to the particular circumstances of the trade in which RNB were engaged.

First National Bank of Chicago

The Department’s narrow application of the RNB decision was challenged by the London branch of FNBC. One of FNBC’s activities was dealing in forex as a market maker but no specific transaction fee or commission was invoiced by it, as like any market maker it looked to make a profit from its forex dealings as a result of the spread between its bid and offer quotes. The Tribunal found in favour of FNBC and the Department appealed to the High Court who referred the following two questions to the ECJ:

a. Do such foreign exchange transactions constitute the supply of goods or services affected for consideration?
b. If there has been a supply of goods or services affected for consideration, what is the nature of the consideration in relation to such transactions?

The ECJ found that forex transactions are supplies of services effected for a consideration within the meaning of the then Article 2(1) of the Sixth Directive (now Article 2 (1) of the VAT directive). In answering the second question it held that the taxable amount/consideration where there is no separate fee or commission is the net result of a number of transactions over a period of time.

Willis Pension Trustees Ltd

The pension fund administered by Willis included a number of overseas investments whose earnings and value would be subject to fluctuations in the sterling exchange rate. Willis entered into an agreement with The Record Currency Management Ltd (“Record”) to act as its agent in forex transactions in order to minimise the pension fund’s exposure to such currency fluctuations on its overseas assets. Willis claimed back as input tax some of the VAT charged by Record but the Department took the view that the VAT charged by Record was wholly attributable to exempt forex supplies made by Willis.

In appealing this decision Willis contended that they made no supply to the bank but were the bank’s customer and argued that they did not offer a spread nor charge a commission and that as a consequence there was no consideration and therefore they were not making a supply of forex.

In allowing the appeal, the Tribunal took the view that for there to be a supply there had to be consideration that could be identified and that it should be the result of the transactions of the supplier. The Tribunal decided that any “profit” retained by Willis from its forex transactions was not something retained for doing something and that it was not a fee, or commission or spread. It was instead derived from something external to the transaction, being the fluctuations in market rates, so any profit was from holding a position and not from any activity of providing a service to its bank as a counter party.

Determining if forex transactions are supplies for VAT purposes

The tribunal decision in Willis applied to a very specific set of circumstances and, whilst some general principles can be drawn from the decision, care needs to be taken when seeking to give it wider application. The ECJ judgment in FNBC is the leading authority on the VAT treatment of forex transactions.

In Willis, forex deals were entered into for the purposes of ‘hedging’. This is a term that is variously defined, but ‘hedging’ is about reducing exposure to risk of loss resulting from fluctuations in some commodity or financial market. What is relevant for VAT purposes is whether any underlying trade is performed to achieve that objective. ‘Hedging’ is not in itself a test for determining whether or not there is a supply for VAT purposes.

In general, forex transactions are supplies for VAT purposes if a spread position over a period of time is adopted when buying and selling currency. This applies whether this is being done for a business’s own account, in support of other activity areas of the business, or to reduce any exposure position in forex that the business might hold. A spread position means a difference between a bid price and a sell price from which the business would expect to derive a profit. These forex transactions would include both ‘spot’ and ‘forward’ transactions, as envisaged by the FNBC judgment.

Most businesses actively involved in forex trading should readily be able to identify whether their forex transactions fall under the FNBC principle of adopting a spread position. If uncertainties remain, it will be necessary to consider whether, in selling a currency, a business is in a position to set the selling price. If so, the business is able to determine the consideration it will receive by setting a spread, even if only mimicking market movements, and the forex transactions of the business are likely to be supplies for VAT purposes.

Where the forex transactions are supplies, the consideration will be the net result of all the business’ forex transactions over a period of time and would be exempt under VATA 1994, Sch. 9, Group 5, Item 1. Any forex transactions, for which an attributable fee or commission is charged, would also be exempt supplies under Item 1.

The following are examples of circumstances when it is unlikely that a business’s forex transactions would be seen as supplies for VAT purposes:

  • a business simply exchanging one currency for another to realise foreign earnings into sterling, for example, or to acquire currency to settle liabilities incurred outside the UK, is unlikely to be seen as making supplies for VAT purposes provided such transactions are not part of a wider economic activity being carried out for an identifiable consideration;
  • a business entering into forward forex deals in order to limit its exposure to forex fluctuations in respect of future obligations is unlikely to be seen as making supplies for VAT purposes provided such transactions are not part of a wider economic activity being carried out for an identifiable consideration.

Businesses with a corporate treasury operation active in the financial markets would need to look carefully at their forex transactions. If no spread position is being taken and no profit being actively sought, it is unlikely that any forex transactions would be regarded as supplies. However, a number of larger businesses have corporate treasury operations that are much more pro-active, either externally or internally, within their commercial groups. For example, a business might typically run a ‘forex desk’ in a similar manner to any other financial institution or market maker more traditionally associated with forex dealing. Such businesses are likely to be taking a spread position and would be making supplies. All their forex transactions, whether spot or forward and whether proprietary or in support of other activities or areas of the business, should be treated as forex supplies.

Intermediaries acting in relation to a forex transaction can exempt their intermediary services under item 5, Group 5 of Schedule 9. This applies whether or not the underlying forex transaction is a supply for VAT purposes.