Out-Law Analysis | 29 Jun 2016 | 11:48 am | 5 min. read
This is part of Out-Law's series of news and insights from Pinsent Masons experts on the impact of the UK's EU referendum. Watch our video on the issues facing businesses, and sign up to receive our 'What next?' checklist.
Current VAT rules are set out in UK legislation, but based on an EU directive which requires member states to impose VAT at a minimum rate of 15%. UK courts and tribunals must apply VAT in accordance with the Principal VAT Directive (PVD) and assorted regulations, as well as EU case law. As such, VAT has the largest European dimension of any tax.
The monetary value of VAT to the UK government is such that it will almost certainly continue once the UK leaves the EU. Even once formal exit negotiations are concluded, VAT cases will be decided by reference to the law in force at the time of the matters in dispute. Given the slow progress of tax cases through the UK legal system, it is not inconceivable that UK courts could be applying EU law principles well into the 2020s – however, the extent to which these principles will be enforced may be the subject of some debate, and we cannot rule out the imposition of a statutory limit on the court's ability to apply EU law.
For on-going and planned references to the Court of Justice of the EU (CJEU), it must be business as usual in terms of the UK courts' and tribunals' ability to make references and for the CJEU to reach judgments. However, those challenging a decision by HMRC on a point of EU law would do well to consider whether the judgment handed down would be implemented in full by the UK courts, which may well be influenced by wider considerations to interpret CJEU judgments in line with the new political realities.
Here, we set out some of the immediate questions for financial services companies that the UK's vote to leave the EU raises in the context of VAT.
Financial intermediary services
The CJEU has consistently told the UK that its VAT exemption for insurance intermediaries is too wide, as it has been applied to claims handling and other third party services 'carved out' from the scope of the exemption by EU jurisprudence. Perhaps now will be the time for the UK to reject the CJEU's interpretation of the VAT exemption for insurance and "related services performed by insurance brokers and insurance agents", thus assisting the insurance outsourcing and offshoring industries.
However, as EU case law has shown, not every decision by HMRC benefits financial firms. CJEU decisions such as that in the CSC Continuum case prevented a narrowing of the UK's interpretation of the general exemption from VAT for financial services. If, as is likely, HMRC increasingly marginalises or ignores EU jurisprudence that goes against its own thinking, it may be that credit intermediaries, brokers and corporate finance services find themselves subject to greater application of VAT on their services.
Input tax recovery
Irrecoverable input tax is a huge burden for financial services companies. Recovery is largely based on an analysis of non-EU transactions: the same transactions with UK and EU counterparties do not grant a right to recovery. Once the UK leaves the EU, could it be that all transactions with non-UK counterparties will grant a right to recovery? If so, banks and other financial firms could vastly reduce irrecoverable VAT on cost base items, such as IT.
It may be that, in order to assist struggling banks, the UK may be minded to repeal or soften the legislative changes introduced following the CJEU's 2013 decision on branches in the Credit Lyonnais case. The CJEU ruled that the French bank was not entitled to take into account the turnover of its foreign branches for the purposes of calculating deductible VAT in France, prompting changes to UK law to exclude certain supplies made by overseas branches from partial exemption methods.
Outsourcing and offshoring
Outsourcing deals have always been fraught with difficulty from a VAT perspective. The scope of the exemption for the outsourcing of services is subject to interpretation and frequent challenge by HMRC, and the risk of this is exacerbated by the long-term nature of many of these contracts.
The transition of the UK from the EU is likely to increase the risk of falling foul of a changing legal basis for the exemption. As such, businesses should ensure that the risks of changing VAT liability are adequately covered in VAT and change of law clauses in their contracts.
Payment services and fintech
Both the UK and the CJEU's approaches to VAT and payment services have traditionally been reasonably well aligned, in that they have both sought to limit the scope of the exemption for technology facilitating such transactions. The latest CJEU judgments in this area appear to limit the exemption to those parties actually transferring funds, while ruling out those parties providing technology services that are indispensable for such transactions but that do not actually transfer funds themselves.
Early UK tax treatment granted to new technology such as bitcoin and blockchain transactions appears to provide greater scope for exemption than that extended to more established providers. In a bid to keep the UK's thriving fintech sector, it may be that the UK is minded to facilitate greater relief from VAT than that allowed by EU-based competitors.
Collective investment vehicles
After a series of setbacks, the UK has seemed finally ready to rewrite domestic VAT legislation in order to bring it more into line with recent CJEU decisions affecting collective investment vehicles. As the UK's longstanding policy appears to have been to offer a narrower exemption in this area than that provided for by EU law, leaving the EU may well delay or even eliminate that move.
If post-exit regulatory passporting issues can be resolved in favour of UK fund managers, than a mismatch between the UK and EU exemptions could work in their favour.
The UK's implementation of the CJEU's 2014 decision against Skandia, the insurance business, has been patchy. In the Skandia case, the CJEU ruled services supplied by the company's US headquarters to a Swedish branch which was VAT grouped with other local companies were subject to VAT, as the branch could no longer be treated as being the same legal entity as its head office.
Freed from the pressure to comply with EU jurisprudence, the UK may well do all it can to facilitate VAT-free head office/branch transactions. Of course, it seems likely that any such transactions would remain subject to the anti-avoidance mechanism in s43(2A) of the UK's VAT Act.
Finally, the UK leaving the EU means that we could finally see the end of recurring threats that the Commission will take away the zero-rating of the Terminal Markets Order.
Darren Mellor-Clark is a VAT and indirect taxes expert at Pinsent Masons, the law firm behind Out-Law.com.