UK’s finance sector urges Kovács to press ahead with VAT reforms

The UK’s financial services industry is pressing László Kovács, the European commis-sioner for taxation, to lighten the tax burden on companies in his forthcoming revision of sector-specific VAT rules.

Current rules exempting financial services products from VAT are set out in the sixth VAT directive of 1977. A consultation on changing the legal framework for the sector was launched last year, with strong views submitted by organisations including the Association of British Insurers and the British Bankers’ Association.

They claim that the current regime is penalising firms. Market restructuring in recent years has meant that banks and insurers outsource an increasing amount of service-related activities, for which VAT is imposable. But such firms are unable to charge VAT on their own products and services.

There are anomalies created along the financial services food-chain. Firms unable to deduct VAT on goods or services supplied to them often pass on the hidden costs to consumers.

According to the industry, the current lack of legal clarity means that VAT treatment often has to be debated with national authorities on a case-by-case basis, which is especially cumbersome for firms operating across national borders. The current regime is widely viewed as an obstacle to cross-border consolidation of the financial services market.

Peter Mason, a London-based lawyer at law firm CMS Cameron McKenna, who is representing the British Bankers’ Association, said that firms that had outsourced product-related activities often ended up being "clobbered" by the present system. "It’s a question of fairness," he said. "If the Commission doesn’t get it right, companies will leave."

Kovács has said that he will modernise the definitions of financial and legal services exempted from VAT. In a speech last week (15 November), he indicated that he would reduce the impact of non-deductible VAT on banks, "which has increased as banks have concentrated more on core activities or tried to rationalise their own internal service structures".

But winning the approval of member states will be hard. Any lightening of the burden on firms will mean less money for national treasuries. Kovács’ room for manoeuvre will be limited as tax rules require unanimity among member states.

In recent years, the European Court of Justice has filled the gap left by the current regime’s shortcomings. Earlier this year, for example, the court held that management fees charged to UK investment trusts should be exempt from VAT. The ruling was a victory for investment firm JP Morgan. "We’ve had a lot of rulings that went against member states. At the end of the day, a lot of them might prefer legal clarity," said a Commission source.

The UK’s financial services industry is pressing László Kovács, the European commis-sioner for taxation, to lighten the tax burden on companies in his forthcoming revision of sector-specific VAT rules.