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Minimising VAT in financial services Back  
In the EU VAT is a significant cost for the financial services industry. Because most financial services are treated as exempt from VAT, the financial service industry is largely treated as a ‘final consumer’ for VAT purposes, and forced to bear the VAT cost. Banks, insurance companies, brokers, fund managers, all need to pay attention to minimising their VAT cost.
Because most financial services are treated as exempt from VAT, the financial service industry is largely treated as a ‘final consumer’ for VAT purposes, and forced to bear the VAT cost.

Unfolding mystery
Revenue challenges mainly come after particular arrangements are in place for several years. If the financial service operator VAT treatment applied to a particular service is proved to be in the wrong, they can find they are faced with this can result in large VAT bills going back several years. This VAT is not recoverable VAT in most instances. The key to good management in the area is not to seek advice after a Revenue challenge has emerged several years down the road. The advice should be taken now, while steps can still be taken to minimise VAT and avoid unexpected tax charges in years to come.

The key issues
There are probably four key areas that a financial service operator needs to consider.
• The status of intermediaries and the services they provide
• The status of any outsourced services
• Reverse charges
• Input credit recovery.

Intermediaries and Outsourced Services
If a financial service operator managed to be completely sellf-sufficient, writing all its own software, manufacturing its own computer terminals, carrying out all tasks using its own staff through every phase of the overall financial service, it would probably minimise its VAT so that it became a very small cost indeed.

However what might seem sensible from a VAT viewpoint, building up a larger vertically integrated empire that is completely self-sufficient, makes no economic sense. There is therefore a conflict between VAT as a cost to the financial service industry, and the efficiency requirements of the industry to outsource and specialise.

The key to a successful resolution of this conflict is to ensure that the outsourced service itself constitutes an exempt service, so that the fee charged to the financial service operator buying the service does not attract VAT.

There have been several cases before the European Court of Justice as to when the service provided by a financial intermediary, or by business to which a financial service company has outsourced part of its functions, are themselves exempt. What is apparent from the case law is that in some instances only small variations in the functions outsourced, and the terms on which they are provided, can make the difference between an exempt service, and a taxable service giving rise to a dead cost VAT charge.

When exempt
In relation to the VAT treatment of the outsourcing of banking services, the leading case is Sparekassernes Datacentre (SDC) v Skatteministeriet (Case C-2/95). SDC is an association in Denmark whose members are savings banks. SDC provided to its members and other customers connected to its data-handling network, services including the execution of the transfer of funds.

The European Court of Justice set out a number of important principles in determining whether outsourced services, such as those performed by SDC, could come within the scope of VAT exemption. Firstly the Court held that the identity of the person supplying the service and the manner of delivery of the service were irrelevant in determining whether the services come within the scope of VAT exemption. Instead, the determining factor was the nature of the services provided. To come within the scope of VAT exemption, the services provided, viewed broadly, had to form a distinct whole, fulfilling in effect the specific, essential functions of the VAT exempt service.

For example, to be treated as coming within the VAT exemption for transactions concerning transfers, the services provided must have the effect of transferring funds and entail changes in the legal and financial situation.

The mere fact that a service is essential for the provision of an exempt service is not enough to ensure VAT exemption as illustrated in the UK case of CSC Financial Services Ltd v The Commissioners of Customs and Excise (Case C235/00). CSC provided a call-centre service for financial institutions whereby they provided potential investors with all the information required regarding the processing of investment forms in relation to the investment in a unit trust including checking that the form was properly filled in, that the applicant satisfies the conditions of eligibility and that the correct payment was enclosed. However, a separate company carried out the formalities for issuing and transferring the units in the unit trust.

CSC argued that the services it provided were specific to and an essential part of the issue of securities by the financial institution and therefore the services should come within the scope of VAT exemption for the ?issue or transfer of securities. The Court did not accept this argument and held that services of a physical, technical or administrative nature which do not alter the legal or financial situation do not come within the scope of the exemption.

In relation to insurance transactions, the key case is that of Card Protection Plan (CPP) v Customs and Excise Commissioners (Case C-349/96). CPP offered holders of credit cards, on payment of a certain sum, a credit card protection plan which was intended to protect them against financial loss and inconvenience resulting from the loss or theft of their cards or other items such as car keys, passports and insurance documents. CPP was not itself and insurer but obtained insurance cover by instructing an insurance broker to arrange a block policy from an insurance company.

The Court held that in order for the exemption to apply, it was not necessary that CPP was in itself an insurer. Instead, provided that the service provided was insurance, VAT exemption could apply. The Court held that the essentials of an insurance transaction were that the insurer undertook, in return for prior payment of a premium, to provide the insured in the event of materialisation of the risk covered, with the service agreed when the service was concluded. These criteria where satisfied by CPP.

A more recent European Court of Justice case, Assurandor-Societet v Skatteministeriet (Case C-8/01) confirmed that VAT exemption for related services performed by insurance brokers and agents applied only where the broker was a mere intermediary between the insurer and the insured. It held that motor vehicle damage assessments carried out on behalf of its members by an association whose members were insurance companies were not VAT exempt.

In view of the above, it is clear that where a financial services operator out sources services, by careful structuring of the legal and commercial arrangements between parties it may be possible to avail of VAT exemption. Small changes in the commercial arrangements can make a big difference to the VAT treatment.

Reverse charges
A number of services, when received across border including from another Member State, attract a VAT liability in the country of the recipient. Since all VAT charges are potential costs to a financial service operator, it is important to review the extent to which services are obtained across border and analyse whether or not they will attract a reverse charge liability under EU VAT rules.

Input recovery
Even where the services being provided by a financial service business are fundamentally exempt, those services can attract input credit when provided to a business customer established outside the EU. It is therefore important that a financial service business has in place systems to identify services rendered to persons established outside the EU so that they may begin to maximise their input recovery. Failure to properly identify such services costs money.

If a financial service business does have significant business with customers in the ten states which will join the EU on May 1 2004 it should identify what impact the accession will have on VAT recovery rates. From May 1 services supplied to customers in those states will not count towards VAT input credit recovery. Prior to May 1 supplies do count in computing input credit recovery.

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