In its October 2022 decision in O. Fundusz Inwestycyjny Zamknięty reprezentowany przez O S.A. (Case C-250/21), the Court of Justice of the European Union (CJEU) confirmed that a sub-participation falls within the exemption from VAT for granting credit.  The decision will be a relief for banks and other lending institutions, after Advocate General Medina’s opinion in this case earlier this year, which suggested that a sub-participation might not be exempt from VAT.


The provision of loans, including transfers by lenders of their interests in a loan, is widely understood to be exempt from VAT across the EU and in the UK (see Directive 2006/112/EC Art 135(1)(b) and VATA Sch 9 Group 5 item 2).  Correspondingly, lenders are often unable to recover VAT costs incurred as part of their business.  Sub-participations (under which the lender of record remains the same, but some or all of the economic risk is transferred to a third party participant) are often used in circumstances where a full legal transfer of a loan is not possible.  At least in respect of funded participations, sub-participations have generally been considered a granting of credit from the sub-participant to the original lender (and therefore exempt from VAT).  If VAT had applied to sub-participations (even if only on the discount or return earned by the sub-participant), significant market disruption could have resulted, and lenders may have been forced to insist on greater flexibility for transfers in credit agreements.

This decision arose out of a Polish tax authority ruling that a sub-participation was not exempt from VAT.  A Polish investment fund paid an upfront amount to a loan originator for an interest in the future proceeds received by the originator from a debtor under an existing loan (with no recourse to the originator in the event of default by the debtor).  The arrangement was consistent with the typical arrangements under the LMA Master Funded Participation Agreement.  Poland argued that the sub-participant fund was providing a service to the originator, and that the consideration received by the fund was subject to VAT.

The Advocate General’s opinion described the sub-participation as a combined service of funding the principal loan and managing the originator’s credit risk.  In her view, this was a complex and indivisible supply that did not fall within the “granting of credit” exemption, which was intended to capture more traditional credit transactions rather than the transfer of credit risk to a third party.

CJEU Decision

Unusually, the CJEU took a different view from the Advocate General, and confirmed that the sub-participant was granting credit: the sub-participant was bearing the risk and reward of the underlying loans, and it was sufficient that capital was provided for remuneration, so that the exemption from VAT applied.  The court agreed that the sub-participant was providing a service to the original lender, and did not have a difficulty with the fund not being a “traditional” lender or not becoming the formal lender to the borrower.

As the CJEU’s decision focused on the payment of capital, a question remains on whether a risk participation (under which the participant agrees to reimburse the lender on future defaults by the borrower, rather than a funded participation where an upfront payment is made for the participation) will receive the same treatment.  Secondary market participants generally consider a risk participation to be exempt from VAT (but not necessarily as a grant of credit).  (A separate exemption under Art 135(1)(c) also relates to credit guarantees.)  The UK tax treatment of risk participations may also differ from funded participations in other ways – e.g. payments under a risk participation are generally not considered “interest” but may be subject to withholding tax as “annual payments”.

The CJEU decision remains relevant to UK VAT.  Despite Brexit, the UK implementation of VAT continues to closely follow the EU directive, and CJEU decisions continue to be influential in the interpretation of corresponding provisions of UK VAT law.