Changes to the U.K.’s Value Added Tax (“VAT”) rules in 2010 have already had a significant impact on the insurance industry, and there may be more to come. This article gives an overview of the main points and suggests methods of mitigation.
As from 4 January 2011, the U.K.’s standard rate of VAT will increase from 17.5% to 20%. Although this is of little consequence for the underwriting of insurance and reinsurance contracts (“supplies of insurance and reinsurance”), which will continue to be exempt, it will significantly increase the irrecoverable input VAT suffered by U.K.-based insurance businesses.
The “reverse charge” trap — back-office outsourcing
Perhaps that rate increase is a fitting way to end a year which began badly with fundamental changes to the U.K. “place of supply” rules. Those changes brought certain outsourced backoffice services within the “reverse charge” regime for the first time.
The reverse charge is a self-reporting, self-accounting VAT procedure for U.K. recipients of supplies from abroad. When you buy services from suppliers in other countries, you may have to account for the VAT yourself and effectively act for VAT purposes as both the supplier and the customer. You charge yourself the VAT and, assuming that the service relates to VATtaxable, non-exempt supplies that you make, you also claim it back, in which case there should be no net cost.
The reverse charge does not apply where the received services would have been VAT exempt had the supplier been in the U.K.
The U.K.’s VAT rules in relation to insurance and intermediary/ broking services are over 30 years old, and in the intervening period the outsourcing of back-office functions has grown significantly. An influential factor in that growth has been the tax advantages, including VAT savings, of “off-shoring”. In some cases, the provision of services such as claims handling, accounting support and IT maintenance, which otherwise might be expected to be standard-rated for VAT purposes, have been accepted by HM Revenue and Customs (“HMRC”) to be within the insurance VAT exemption when supplied to insurance businesses. The extension in early 2010, however, of the reverse charge regime to the supply of certain back-office functions signalled a change and, as a result, U.K. insurers have begun to suffer irrecoverable VAT on outsourced services, even where the service provider is established outside the European Union (“EU”) member states.
The potentially negative consequences of this have to some extent been mitigated by HMRC’s arguably generous view to date of which offshore back-office services would qualify for exemption from VAT if they had been supplied in the U.K. However, in recent months a number of press reports have indicated that the U.K. government may succumb to pressure from other EU member states to apply a narrower view of those insurance-related services which qualify for exemption. The EU is in the process of reviewing its policy on VAT exemptions for insurance and financial services, and a key consequence is likely to be a revised definition of exempt services for the insurance industry. Whilst the U.K. has proposed a wide definition, broadly in line with its existing policy, a number of other member states have pushed for a narrower definition which would exclude many back-office functions from the exemption.
Although the U.K. Treasury is continuing to seek comments from industry on the proposals, reports are beginning to surface that the battle may already have been lost. If that proves to be correct, insurers will need once again to review their outsourcing policies so as to maximise any remaining opportunities for exempt treatment.
Rise in standard rate of VAT
Whatever the outcome of the European debate, the irrecoverable VAT suffered by U.K. insurance businesses will inevitably increase in 2011 as a result of the rise in the standard rate of VAT to 20%, with effect from 4 January 2011. Insurance businesses, in common with other partially-exempt businesses, should be considering urgently their year-end billing and payment arrangements for supplies received either side of 4 January 2011 or which, in the case of some services, actually straddle that date.
It is likely that the default position for most suppliers will be to charge VAT at 20% on all invoices issued after 4 January 2011, even when the supply actually took place before that date. Although most businesses will recover their input VAT in full, insurance and other partially-exempt businesses will unnecessarily increase the irrecoverable VAT which they suffer by unthinkingly paying VAT at 20% on all post-4 January invoices. Partially-exempt businesses should instead consider asking their suppliers to apportion such invoices so that the element of consideration referable to pre-4 January supplies is charged at 17.5%. Clearly, this may be seen as an inconvenience for suppliers, so an early approach on this basis is likely to get a more sympathetic response.
Better still, there is some opportunity to mitigate the initial cost of the increase by, in effect, asking suppliers to invoice early. In some cases, the VAT “time of supply” is ascertained by reference to the date of an invoice rather than the date on which a supply is actually made. So, an early invoice can advance the “tax point” for post-4 January supplies and, if issued before the rate increase, reduce the rate charged. If the “tax point” is before the date of the change, the current rate of 17.5% applies, even though the services may actually be carried out after 4 January.
This may sound too good to be true, and the potential for advancing the “tax point” to benefit from the 17.5% rate is not open-ended. In order to stop abuse, there are “antiforestalling” measures which, for example, would prevent this technique being used in relation to back-office services supplied by a connected party. However, in relation to third-party transactions on genuine commercial terms, insurance companies, along with other partially-exempt businesses, do have the opportunity to mitigate the initial cost of the rate increase.
“Click through” services
Finally, in an otherwise gloomy year, a little good news. HMRC has issued new guidance following its defeat in the Court of Appeal case, HMRC v Insurancewide.Com Services Ltd. The Court’s decision is not to be appealed, and HMRC now accepts that internet introduction services which direct potential clients to insurers, so-called “click through” services, may be exempt for VAT purposes provided (in particular) the service provider is more than a mere conduit.
In order to meet this test, the service provider will need to satisfy four conditions:
- the services are provided by someone engaged in the business of putting insurers in touch with potential clients;
- the business provides the means by which potential clients are introduced to insurers;
- that introduction is made when the potential client is looking for insurance; and
- the introducer plays a proactive part in putting in place the arrangements under which the introduction is effected.
This guidance is a useful explanation of how the VAT exemption will be applied to web-based intermediary services, and HMRC has even confirmed that businesses can reclaim qualifying VAT overpaid under the old rules.