EU banking & insurance VAT exemption overhaul rolled into wider financial services tax review
The EU’s long term aim to withdraw the outdated VAT exemption on financial services has now been rolled into a wider examination of the taxation of the sector. Concerns around the recent inflation spike had put the reforms on hold.
There is a study being undertaken for the European Commission with Syntesia into the tax framework for insurers, banks and other financial services subsectors. The consideration is if member states’ taxes “hinder cross-border operations and hamper digitalisation, competitiveness, and innovation in the Single Market”.
There are been several attempt to look at removing the exemption, but they have been derailed by inflation concerns or arguments between member states of the treatment of outsourced services – see below. Broadly, there are three reforms for VAT being muted:
- Withdrawing the exemption and fully taxing financial, banking and insurance services; or
- Limiting the scope of the exemption to tax only some types of services (e.g. fee-based as opposed to interest-based services)
Apr 2022 -Legislative proposal on ending VAT-free banking and insurance delayed with cost-of-living crisis
The European Commission has completed a public consultation on potentially withdrawing the VAT exemption on financial services – banking, insurance and similar. It published the submissions in August 2021. Proposed VAT Directive amendments will likely be published in early 2023. This is part of the 2020 EU Tax Action Plan.
Cost-of-living crisis may delay beyond 2023
Ideas around an interim 10% VAT rate (for example) are unlikely to raise material revenues since financial services companies will recover equal amounts via the right to deduct. However, member states are already pushing back on going to full, standard VAT rate on fears of the cost-of-living crisis and any increase in taxes feeding through to consumers adding the problems.
Euro-zone inflation in March 2022 hit 7.4% (5.9% in February) compared to the 2% target of the European Central Bank. This is the highest in over twenty years.
VAT on fee-based only services?
The likely outcome is VAT being imposed on fee-based services only, with a continuing exemption for credit services. In addition to tackling long-standing problems over what to impose VAT on and outsourcing exemptions, the EC wants to emerging services into the review:
- Crypto currencies;
- Fintech services;
- Payment services; and
- E-money
Follow all the European Union’s completed and planned reforms via VAT Calc’s EU VAT reform tracker.
5 models for VAT on banking and insurance
The EC has already proposed five different VAT models for financial services, all of the including fresh legislative definitions based on recent European Court of Justice rulings:
- Standard rate with option for fixed rate reductions
- Reduced rate with option for fixed rate reductions
- Standard rate on investment services with fixed rate deductions
- Reduced rate on investment services fixed rate deductions
- New cost-sharing arrangements
50 years of banking and insurance VAT pain
The exemption dates back to 1977 and reflects the challenges of imposing VAT on complex business models and the risk of excess taxes being passed onto consumers. But problems over the interpretation of the exemption have created a large amount of tax cases at the European Court of Justice in recent years (see below). There is a heavy level of cascading VAT through the sector as banks, insurers, pension funds etc are unable to recover their input VAT. This creates market distortions as well as uncertainty around the definition as to which activities are subject to the exemption. The major problems include:
- Proportional deductions
- VAT grouping
- Cost-sharing arrangements
- Options to tax
In addition, the complexities and discrepancies.of the rules across the different member states means that the exemption is likely to be hindering the development of cross-border financial services in the Single Market.
The exemption as it relates to intermediaries will also attract special attention. Particularly given their strengthened roles under MIFID and IDD.
With the UK out of the EU, many of the disagreements in the past over compromises should melt away. The UK is planning its own review of the VAT exemption. Countries such as China, New Zealand and South Africa have since imposed their VAT fee-based services, which is simple to determine. They have kept credit as exempt.
B2B Opt to tax use
In an attempt to alleviate some of the problems, the EU VAT Directive does allow member states to permit financial services firms to opt to tax – removing the exemption. This is only on B2B transactions. Recently, a number of countries have adopted or extended their use of this ‘may’ option:
Financial Services VAT exemption creaking under complexity and court rulings
The impact of the EU VAT exemption presents many long-standing problems for the sector:
- a lack of VAT neutrality and unrecoverable tax (businesses being unable to reclaim VAT associated with financial and insurance services)
- legal uncertainty for businesses
- high administrative and compliance costs
ECJ taking on law-making role
The result has been a disproportionate recourse to tax courts, including the European Court of Justice as the last resort. This brings problems as a route to regulate the tax:
- case law offers no legal certainty;
- it creates a quasi-legislative role for the court; and
- it does not guarantee consistent harmonisation, and therefore further contributes to the distortive effects of the VAT exemption and to divergent judgments regarding the same legal provisions.
2011 discussion stalled by UK
The last serious attempt to reform VAT on financial services was ended in 2011. The UK and Ireland could not reach agreement on the treatment of outsourced and commodity services. However, with the UK now out of the European Union, the likes of Ireland may not have enough support to block special carve outs first sought by the UK with its powerful financial services lobby.
How can VAT Calc help?
Our VAT Calculator tool is build on the taxing legislation of the EU member states, and other major countries such as the UK. This means the exemption rules, options to tax etc. are already backed in, and can be easily adjusted via our VAT Script to reflect your operational model, jurisdiction and views on interpretation.
