Rishi Sunak has recently confirmed that, from 1 January 2021, UK financial institutions lending, providing ECM/DCM underwriting services or insurance related supplies to EU customers will be able to benefit by recovering VAT on their costs (input VAT) attributable to these supplies. At present, this is only possible where these services are supplied to customers outside the EU.
If this position is indeed enacted (assuming it survives the next couple of weeks of Brexit negotiations), many UK financial and insurance businesses may benefit from significantly reduced VAT bills and will need to consider the implications of this for their pricing of supplies of such services. However, businesses which have used cross-border VAT grouping arrangements should check carefully to ensure that their partial exemption positions are optimised to reflect these changes.
Background
Businesses cannot generally recover VAT on costs associated with exempt supplies, such as financial and insurance services, with the result that the VAT that they pay out is an absolute cost. However, the UK regulations (implementing the EU VAT directive) currently provide that input VAT on many of those services can be reclaimed or set off against VAT due to HMRC where such supplies are made to customers outside the EU.
Early last year, the government published a number of draft statutory instruments in readiness for a no-deal Brexit. These included proposed regulations extending input VAT recovery treatment to certain exempt financial and insurance supplies exported to the EU, and it is these that the Chancellor has confirmed will come into force next year.
It is worth noting that the Chancellor's statement was silent as to whether this confirmation was contingent on the UK and EU failing to reach agreement on a trade deal. It is not clear whether this reflects Government policy to enact the regulations even if a trade deal is agreed or whether, following agreement, the position may yet change again.
Cross-border supplies
These regulations would mean that UK businesses will be in a better VAT recovery position when exporting their services overseas (regardless of the location of the customer) than if supplying these services to UK customers.
While this appears counterintuitive, the VAT Directive puts EU financial institutions and insurance businesses in the mirror position i.e. that their equivalent exempt supplies to the UK, as a non-EU country, would acquire the right to recover VAT on associated costs, but that supplies of such services within the EU would continue to incur irrecoverable input VAT.
Given the relative sizes of the EU and the UK, and the importance to the UK economy of financial and insurance service exports, this change is likely to help UK businesses stay competitive although – as the Chancellor's speech last week also addressed – regulatory issues remain troublesome particularly in relation to the lack of clarity regarding the EU's position in respect of granting equivalence to the UK.
In addition, an EU consultation is planned for early next year on reform of VAT on financial and insurance services and one of the options being canvassed is removal of the VAT exemption for these services altogether. The UK needs to keep a close eye on these developments.
Partial exemption
Financial and insurance businesses with subsidiaries resident outside the UK (with UK branches) may have included those subsidiaries in a VAT group enabling the provision of exempt services to the UK branch and, in some circumstances the head office of the subsidiary, to be disregarded.
Such businesses should now look at whether they should remove those subsidiaries from their UK VAT group (or indeed vice versa) to ensure that these types of cross-border exempt supplies (i.e. those which will carry a right to recover input VAT) are, from next year, taken into account in their partial exemption recovery calculations – and thus their overall VAT recovery rate. This will depend on the relative levels of supplies between (i) the non-UK establishments of those subsidiaries and the UK members of the group and (ii) the UK fixed establishments of those subsidiaries and other UK members of the group.
