Europe reviews VAT regime for financial services

Much of the current VAT regime is almost 30 years old and an unpleasant environment for many financial services companies, particularly those that trade across EU borders. But the European Commission announced plans for reform yesterday.

The Commission has launched a consultation which looks at changing the current legal framework, as set out in the Sixth VAT Directive of 1977. Since implementation, the provisions in this Directive which govern the treatment of financial services and insurance have never been re-visited legislatively. A re-visit is overdue, it appears.

The 1977 legislation exempts financial services and insurances. This creates "hidden VAT" charges in supplies from financial and insurance services providers to other businesses. Indeed, they cannot deduct input VAT on services or goods (e.g. computers) supplied to them because the services they supply themselves are exempt. Their charges to customers will therefore reflect this VAT cost and, as it cannot be recovered by business customers, cascades through the system, increasing the cost of the goods and services they themselves supply.

There are other problems.

Hein Blocks, Chairman of the European Banking Federation's Executive Committee, said the current VAT regime "is a major obstacle to cross-border consolidation in the banking sector and puts banks at a competitive disadvantage compared to non EU competitors."

The Association of British Insurers (ABI), whose members provide over 97% of the insurance business in the UK, says insurers suffer additional VAT costs purely as a result of outsourcing insurance-related activities, a cost ultimately borne by the policyholder. This was the accepted UK practice; but a recent case before the European Court of Justice threatens to charge VAT on outsourced insurance services.

The ABI also points out that VAT rules discriminate against insurers doing business across borders in the EU by creating additional tax costs which would not arise in a fully VATable business or where the business is in only one country. The regime should allow an insurer to compete in the international market on the same terms as other industries, says the ABI.

The Commission agrees that VAT should be applied in a manner consistent with a level playing field. It says it wants to ensure that insurance and financial services customers are not left with "hidden VAT". It also wants budgetary security for Member States, a cut in the administrative charges for the economic operators concerned and an improved definition of exempt services, creating more legal security for Member States and economic operators, and the removal of competitive distortions between supplies across different Member States.

The consultation has been welcomed by the ABI. Peter Vipond, ABI Director of Financial Regulation and Taxation, said: "We are pleased that the EU Commission recognises the current VAT regime does not meet the needs of the 21st Century and we urge Member States to use the review to enhance the EU’s competitiveness in a global economy."

Responses from interested parties should be made by 9th June 2006. The Commission then intends to submit a legislative proposal by the end of 2006 for modernising the current legislation on financial services and insurances.