There are a great number of different activities in the financial services industry, each needing to be classified for VAT purposes in order to determine the correct VAT treatment.
This is a difficult area, and different businesses will actively want different VAT interpretations. Some businesses will have large expenses and taxable clients: they will want to charge output VAT on their services (their customer will recover this) and claim the input VAT on their expenses. Other businesses will have low expenses and private clients: they will want their supplies to be exempt and will accept that input VAT will not be recoverable.
In this article, we will look at some of the issues which give rise to complexity.
Nature of the service
To determine whether or not a supply of a financial service might be exempt, it is important to determine whether the service falls within one of the categories in Group 5, Schedule 9, VAT Act 1994.
In some cases this might be self-evident, but in most cases there is doubt. A fundamental cause of this doubt is that services are usually comprised of more than one element. For example, financial advisers might help secure financial products, crowdfunding platforms often provide a suite of services, fund managers might work on a mixture of funds, brokers might invest on their own discretion and so on.
It is therefore important to determine the nature of the services supplied. The courts have shown that this is a complex process, considering whether the elements of the service combine to form a single supply, how they combine, which elements predominate and assessing the overall character of the service from certain perspectives.
A comparison of two scenarios is instructive as to the complexities of this process.
On 19 July 2012, the CJEU decided in the case of Deutsche Bank AG (C-44/11) that the taxpayer was not only a financial intermediary when it bought and sold shares for its clients, it also decided which shares its client should invest in. The combined supply was too wide for the financial service exemption categories, and the charges by Deutsche Bank were therefore subject to the standard rate of VAT.
Compare this to the guidance issued by HMRC (VATFIN7665) regarding financial advisers who also broker financial products. Simple advice is usually standard rated, even if the subject matter is financial. Acting between the purchaser and seller of a financial product is usually exempt. Most financial advisers combine the two services. However, in contrast to the Deutsche Bank case above, HMRC’s guidance is that these two services, in the right combination, are exempt.
It is therefore important to understand how the fundamental VAT rules apply in each case, to take into account HMRC’s guidance and where necessary to challenge it.
Place of supply
To determine the rate of VAT, it is not sufficient to identify the nature of the supply. It will also be important to determine the place of supply.
Qualifying financial services will be exempt when the place of supply is the UK. However, certain supplies to customers outside the EC will fall outside the scope of VAT, effectively being zero-rated. This is desirable as it removes output VAT from the supply, without restricting recovery of input VAT on attributable costs.
Not all such supplies to non-EC customers can be zero-rated and there are a number of factors to consider, such as the nature of the customer and where the service is received. The place where a service is received depends on where a customer is established or usually resides, and there are further rules when there is more than one such place.
Determining the rate of VAT, as complex as that might be, is not the only difficulty. There are various issues to beware in specific circumstances. For example:
Do your transactions involve supplies of financial instruments, such as shares or bonds? Such supplies should be ring-fenced and a separate partial exemption computation is required for the recovery of input VAT (Section 7 of HMRC’s Partial Exemption Tool Kit 2014).
Do your services involve fund management? Supplies to funds in EC (non-UK) member states require an assessment of whether there are sub-funds, whether there is an “overseas scheme” which is “recognised” by the UK authorities and whether de minimis levels of UK involvement are achieved (Section 7, HMRC Notice 701/49).
Do your financial services involve non-UK branches? A recent CJEU case (Le Credit Lyonnais CJEU C-388/11) has provided some guidance on when to include and when to exclude the turnover of foreign branches in the partial exemption computation. The decision has caused HMRC to change its policy in this complex area.
Crowdfunding is particularly complex. The provision of funds is made in several forms, whether as a loan, in exchange for rewards or in combination. The crowdfunding platforms themselves also provide differing combinations of services. The issue is so complex that it has been referred to the EU VAT Committee and we await their findings.
The first step in considering the VAT treatment of financial services is to gather clear details about the customer and the services they will purchase. A review of all these details is then required in light of the legislation, HMRC’s guidance and relevant caselaw. These are complex processes and guidance is often required.
For further information and help on VAT for financial services, please contact the TaxDesk on 0845 4900 509 and ask for Kevin Hall.