The UK has proposed legislation to take effect on a "hard" Brexit (i.e. if no deal is reached) that puts the UK financial services and insurance sectors at a disadvantage to businesses elsewhere in the EU.
These sectors in the EU are generally unable to recover any VAT incurred in making exempt supplies (such as supplying insurance or granting loans). For example, other than in limited circumstances, a bank cannot recover VAT on legal fees incurred in making a loan to an EU client.
This means that VAT is an absolute cost for these businesses and it generates significant money for tax authorities throughout the EU.
One important exception to this rule is that where one of these businesses provides these services from the EU to a person outside the EU, the VAT incurred to provide these services is recoverable. The reason for this is that it allows EU businesses to compete on an even playing field with businesses in jurisdictions where no VAT applies. For example, if an EU bank incurs this irrecoverable VAT on making a loan to a US person (when an equivalent US bank does not), the EU bank is at a cost disadvantage.
In practice, this means (for example):
- a UK bank advancing a loan to a French borrower cannot recover the VAT it incurs in making the loan (e.g. on legal fees);
- a UK bank advancing a loan to a US borrower can recover the VAT it incurs in making the loan (e.g. on legal fees).
(Whilst this example concerns a bank, the same holds true for an insurer providing insurance.)
The position is uniform throughout the EU, because all EU member states implement their local VAT based on a common set of VAT rules.
What does the proposed UK measure do?
The proposed measure – which seems innocuous on the face of things – simply maintains the current position as far as UK VAT is concerned, so the two examples above will continue to be the case after Brexit.
This covers VAT incurred by both the financial services and insurance sectors.
If the status quo is being maintained, then so what?
The point is less about what the UK is doing and more about what the rest of the EU is not doing.
Whilst the UK is maintaining the status quo, the rules in the other EU member states will automatically regard the UK as being outside the EU (unless the EU legislation itself is changed but, as this would require the unanimous consent of the EU member states, this seems very unlikely and would take time to achieve).
Given the supremacy of EU law in relation to this specific point – even if the local law does not provide for it – this is likely to be the position.
In France, Germany, Italy, Luxembourg, the Netherlands, Poland and Spain, this will definitely be the day-one Brexit position subject to any changes being made to the EU VAT legislation itself.
Consequently on Brexit:
- a French (or other EU) bank advancing a loan to a UK borrower will be entitled to recover the VAT it incurs making that loan;
- this can be contrasted with both (a) a UK bank advancing a loan to a UK borrower and (b) a UK bank advancing a loan to a French borrower because, in both circumstances, the UK bank will not be entitled to recover the VAT it incurs making that loan.
This means that the French bank in this example may have a competitive edge compared to the UK bank (i.e. increased VAT recovery when advancing these products to UK persons).
Although this example concerns a bank, the same holds true across the financial services and insurance sectors generally, where supplies would be exempt if made locally.
Why is the UK introducing this legislation?
There is no clear answer to this.
It may be because (a) the government does not wish for businesses to have the administrative headache of having to update their systems or (b) this VAT block generates substantial revenue for the UK government which it does not wish to lose and does not consider that maintaining this position will incentivise businesses to shift operations out of the UK (perhaps after taking all the relevant factors into consideration, the UK government has obtained comfort that this will not arise).
There is a logic to the UK government's position. However, unless the EU adopts a similar stance in relation to supplies made to the UK, the UK financial services and insurance sectors may be at a competitive disadvantage given the automatic changes to the VAT rules in the remaining EU member states.
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