Since 1 January 2021, financial services (FS) and insurance firms can benefit from VAT savings when providing certain financial or insurance services to EU clients.
Traditionally, FS businesses have only been able to recover input VAT on costs used for providing specified supplies of certain financial or insurance services provided to non-EU customers.
However, from 1 January 2021, the VAT recovery also extends to businesses providing:
- Certain financial or insurance services to the EU (including most intermediary services); and
- Financial or insurance services directly linked to export of goods to the EU.
The definition of taxable supplies within existing partial exemption special methods will automatically cover the extension in specified supplies. However, businesses should still monitor and review whether their current methods remain appropriate.
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Whilst welcome news, as always the underlying detail behind these new rules is far from simple - the definition of ‘certain’ services is key (as some are excluded), and businesses will need to review the treatment of costs relating to the transitional period .
For example, HMRC has recently clarified that businesses can achieve full VAT recovery on costs only if they were incurred from 1 January 2021 and were wholly used for providing such onward financial or insurance related services (i.e. direct costs). If the costs are only partially used for providing such supplies (i.e. overheads), then businesses could benefit from a partial VAT recovery.
The sting in the tail is in respect of costs incurred before 1 January 2021 but which relate to supplies made to EU clients after the change in rules, as HMRC is of the view that such VAT is NOT recoverable. There is also no change to the rules for domestic supplies, as such input tax would continue to be irrecoverable to the extent it is used for providing financial and insurance related services to UK businesses.
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What this means
These rules have been welcomed, as businesses that continue to provide certain financial or insurance related services to EU counterparties are now able to unlock VAT recovery that was traditionally an absolute cost. Of course, following regulatory uncertainty on the passporting rules, many business will have restructured business operations and ceased to provide services to EU customers. However, even where this is the case, the level of supplies made by the UK business which previously inhibited VAT recovery will be removed, which in most cases should result in an increase on VAT recovery on overheads.
It would be prudent and timely for many businesses to review their current partial exemption methods to determine both the likely impact of the change and also whether the existing method remains appropriate or should be updated. Furthermore, business which have undertaken Brexit restructuring projects need to consider carefully the VAT treatment of related and ongoing costs following these rules changes.
Of course, any significant increase in VAT recovery may well trigger a routine VAT inspection. Therefore, it is more important than ever that businesses are happy that their ‘house is in order’ before the VAT man comes calling.
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Alongside these Brexit-driven changes, it is worth noting that HM Treasury has recently conducted a call for evidence on the VAT grouping rules in the UK. Further changes (for example on the question of establishment only or full entity VAT grouping following the Skandia case) are likely in the medium term.
We are also seeing challenges from HMRC on the interpretation of an establishment for VAT purposes, and any business that has a branch in a UK VAT group (particularly those which were set up many years ago) should look to review its position. Test cases on these points will be addressed in the Courts, and further developments are eagerly awaited.
Any further changes arising in respect of the VAT grouping rules and/or the issue of what constitutes an establishment is likely to have a material impact on the FS sector, so businesses should closely monitor for any further updates.
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Businesses should now take the opportunity to review and assess their situation from a VAT perspective, including:
- Has the business traditionally been recovering VAT in line with the old rules?
- Can the business identify what supplies will benefit from VAT recovery under the new rules?
- Does the business incur any direct costs which could benefit from full VAT recovery?
- What impact will the new rules have on the VAT recovery for overheads? Does the current partial exemption method produce a fair and reasonable result – or is there an opportunity to consider alternative methods which may produce a more fair and reasonable recovery?
- How will you implement the rules for supplies that straddle 1 January 2021?
- Does the business have appropriate processes and controls in place to implement the new rules? Are these processes/controls in line with the digital linking requirements of Making Tax Digital which take effect from Spring 2021?
- How will be the business be affected if HMRC introduces further changes to VAT Grouping and rules on establishment?
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For help and advice on this or any other VAT issue, please get in touch with your usual BDO contact or Stephen Kehoe, Aditi Hyett, Vicki Weston or Syeed Reza.