EU proposals to change the VAT treatment of insurance and financial services

On 28th November 2007, the Tax and Customs Directorate of the European Commission “TAXUD” set out proposals to update the VAT treatment of insurance and financial services. These can be found on the TAXUD website, at http://ec.europa.eu/taxation_customs/index_en.htm.

As the Commission admit, many of the old definitions are out of date and do not reflect modern business practice, there has been uneven interpretation by member states, and the current VAT treatment can create distortions. Where insurance and financial services businesses have been moving towards horizontal integration, for example in insurance operations outsourcing, and undisclosed agency arrangements, the VAT regime has failed to keep pace. A key feature of the VAT system (and a reason for its popularity and adoption by many countries in the world) is that it aims to achieve more or less the same final VAT charge at the end of the supply chain, however many stages in that chain. This is known as fiscal “neutrality” and it should apply generally, including in the exempt financial and insurance supply chains, whether there is one big “conglomerate” involved, or a longer supply chain of different suppliers. It is not clear whether the changes proposed here will assist in achieving and maintaining such neutrality.

Redefined exemption for financial services and insurance

The new proposals seek to modernise the VAT law in this area and will involve:

• Revised definitions of insurance, credit, cash and payment services
• Introduction, from 2012, of an option to tax insurance and financial services
• Revised and wider scope of fund management, to cover any collective undertaking including funds
• Exclusions from the exemption for regulatory compliance reporting , except for funds, who benefit from the exemption! Is that fair for insurers?
• Exemption for some financially settled derivatives,( although the language of the directive may need to be clarified). It talks of “ issuance of exchange derivatives”, what then is the VAT treatment of an “off-exchange” or “over the counter” cash settled weather derivative, or of emissions trading of allowances?

Redefined meaning of “intermediation”

One of the areas that requires further clarification is the recasting of the exemption for intermediaries performing a “distinct act of mediation”.

It is not clear if the intermediary needs to disclose their position to the customer in order to gain exemption. There is also an exclusion from exemption for intermediation involving standardised prior instructions, and “standardised services provided by call centres”. These exclusions are not legally very explicit, and seem to focus on the nature of the operator rather than the operation itself. This is often a fatal error as history shows it can lead to tax discrimination. Is this fair to e.g. internet sites which not only hold out an offer, but sift applications and forward only those fulfilling the relevant criteria?

These proposals may therefore not be the end of the story.