Providers of financial and insurance services generally cannot reclaim the VAT they incur on their costs because their services are VAT exempt. However, where financial or insurance services (or intermediary services concerning such services) are supplied to persons belonging outside the EU, input VAT attributable to those services is recoverable under the VAT (Input Tax)(Specified Supplies) Order. That position is shortly to change, following the introduction of amending regulations which will restrict recovery of the input VAT in circumstances where the final consumer of the services belongs in the EU.
These regulations are designed to prevent offshore loop structures that enable VAT costs to be recovered by routing services primarily carried out in the UK via an entity located in a non-EU country. Those services are then used to provide insurance or other financial services back into the EU market. The government's stated concern is that this is contrary to the intention of the VAT system and distorts competition to the disadvantage of domestic UK suppliers, hence it is taking action.
Background – the Hastings case
This issue came into focus recently with the case of Hastings. Hastings is a UK insurance broker which provides broking, underwriting support and claims-handling services to Advantage, a Gibraltan insurance company which underwrites UK general insurance.
If Hastings supplied services to a UK person, these services would fall within the VAT exemption for insurance services and no recovery of input tax attributable to those supplies could have been made. If, however, the services were supplied to a taxable person which "belonged" (i.e. had a business establishment or fixed establishment) outside the EU, then VAT recovery would be possible.
HMRC considered that Advantage belonged in the EU as its supplies of insurance services to UK customers were made in the UK through a fixed establishment comprising Hastings's human and technical resources. This was on the basis that, under the contractual arrangements, the marketing and sale of insurance and related "customer-facing" activities were carried out by Hastings, on behalf of Advantage, through Hastings's staff and systems in the UK.
However, the First-tier Tribunal agreed with Hastings that Advantage made its supplies of insurance to UK customers from its business establishment in Gibraltar (acting through Hastings as broker), received the services to enable it to do so at that business establishment and did not have any fixed establishment in the UK.
Subsequent law change
The Hastings decision is based on the findings of fact made by the Tribunal that Advantage had real substance in Gibraltar and operated as an independent business. Had that not been the case, recovery of input VAT may have been denied.
Notwithstanding that HMRC should be able to challenge similar structures under existing law where there is not the requisite level of substance and independence on the part of the offshore broker, it has subsequently published draft legislation to prevent "VAT avoidance" where input VAT is recovered on exempt financial and insurance services by routing these services through offshore entities outside the EU. The draft regulations do not, however, include any provisions limiting the new rules to cases of abuse or artificiality.
HMRC also stated it would be examining further measures to tackle variations of this type of avoidance, although there has been nothing published as yet.
Comment
Provided the arrangements were not artificial, such "loop" structures were previously a legitimate way of optimising VAT recovery. Once these regulations are made, it will be irrelevant how and for what purpose the structure was put in place; input VAT will be irrecoverable regardless. The introduction by HMRC of a blanket ban on recovery in circumstances where the ultimate consumer of the services is in the EU will increase the input tax costs of those who have implemented such structures. As input tax recovery is currently governed by the VAT Directive, depending on the position reached regarding Brexit, the validity of the regulations may need to be assessed in that context.
Any such "loop" structures should now be reviewed to determine whether they remain viable despite the loss of input recovery, but whether they should be unwound may well depend on the direct tax position.
