EU retreats on reform of insurance VAT exemption

UPDATE 19 Nov: HM Treasury assured the London insurance market that it does not believe that there has been any significant change to the process for the modernisation of the Financial Services Directive.

16 November 2010

The EU Council has indicated that it is unlikely to push forward with major reform of the VAT exemption on insurance and the wider financial services industry.  The current rules - which set VAT on insurance at nil across Europe - were designed in the 1970's, but had failed to keep up with the evolution of the industry and outsourcing trends.  The existing rules now look set to remain in place due to the lack of agreement on potential simplifications, and the distraction of wider EU worries on financial regulation, VAT fraud and the economic crisis.

This development may bring only short-term relief to UK insurers who were anxious that a withdrawal of the exemption on many outsourced services would leave them with a large VAT bill.  Also, brokers were nervous of losing the exempt VAT status of many of their ancillary services which would have forced price rises.  However, the UK's tax authorities may instead be forced to implement the 'Andersen' (see FOOTNOTE below) ruling and withdraw the VAT exemption within the next 1-2 years so that the UK falls back into line with the EU.

globalisation and outsourcing leaves vat rules outdated

When the European law, or Directive, on financial services was introduced in 1977, insurance and banking services were given a blanket exemption from charging VAT.  This meant that services were charged without VAT, but that any VAT on costs incurred were non-recoverable, and so lost.  The principal reason for this approach was that it was considered too complicated to introduce VAT on these services without distorting the market.

However, the increasing use of outsourcing, especially in the UK, has undermined this.   Many companies involved in the insurance chain introduced VAT charges within their services as a way of offsetting the lost input VAT.

eu attempts update of vat exemption

In an attempt to kill off these market distortions, the EU Commission produced the first draft of a new Financial Services VAT Directive in 2007.  This was designed to capture changes in outsourcing in the banking and insurance industry.  The principal proposal was an 'opt-in' to charge VAT and deduct input VAT on outsourced services, plus the pooling of exempt services.

lack of agreement SLOws reform

A lack of consensus on these reforms means that progress may now have effectively stalled.  The current rotating Belgian presidency said: "Whilst the majority of proposed definitions seem to be acceptable to delegations, they will need to be considered against the background of adjustments to the overall tax burden on the financial industry, and in the light of regulatory changes ensuing from the financial crisis."

This news may bring short-term relief to the UK markets, where there was much concern over recent attacks on the popular VAT exemption.  The European Court of Justice this month ruled in the Axa case that some previously VAT-exempt services were declared VATable - meaning fresh costs for insurers.  Also, there has been considerable pressure from other EU countries to close many of the loopholes in the current rules exploited by the UK and elsewhere.

Any delay could mean that the UK tax authorities may have to modify some of its rules to bring it back into line with the rest of Europe - so the exemption may be lost sooner than thought.

FOOTNOTE: Andersen Consulting European Court of Justice Ruling (C-472/03) March 2005

The ECJ, the highest court of appeal in the European Union, that many services provided to insurance companies in the EU were not considered VAT exempt.  This means the supplier should charge the insurance customer with VAT.  Since insurers are VAT exempt, they cannot then recover this 'input' VAT so it represents an increased cost.  Andersens were providing Royal Nederland Verzekeringsgroep, a Dutch insurer, with back office services including accepting new policies and claims handling.  The court held that providing of outsourced services does not constitute the provision of exempt insurance-related services as the provider of the services is not put in the position of an insurer or agent.

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