The CJEU has confirmed in the Polish referred case of Minister Finansów v Aspiro SA1 that a third party acting on behalf of an insurer in the handling and settlement of claims cannot benefit from the exemption for insurance transactions.

This may have repercussions for the UK, as like Polish VAT law, the UK VAT exemption currently covers claims handling, going beyond what is permitted by the Principal VAT Directive2. If the UK votes to remain in the EU, the UK will need to consider removing claims handling from the insurance transactions VAT exemption.

Factual background

Aspiro provided a range of claims settlement services in the name and on behalf of an insurance company, including corresponding with insureds, producing assessments and damage reports, taking decisions on claims and drawing up documentation for claims processing and settlement. Aspiro sought an interpretation from the Polish Finance Minister as to whether its activities were exempt from VAT, who stated that only the processing and settling of substantive claims was an insurance activity. Aspiro challenged this interpretation. The Polish Court requested a preliminary ruling from the CJEU on the question of whether settlement of claims services carried out by a third party in the name of and on behalf of an insurer may be exempt from VAT.

Insurance exemption under EU and UK law

Under Article 135(1)(a) of the Principal VAT Directive, member states are required to exempt from VAT "insurance and reinsurance transactions, including related services performed by insurance brokers and insurance agents".

Going back, in 2005 the CJEU adopted a narrow interpretation of the EU insurance exemption in the UK case of Staatssecretaris van Financiën v Arthur Andersen & Co Accountants c.s..3 In this case, it held that back office services provided to an insurance company do not fall within the VAT exemption in the Principal VAT Directive for insurance transactions where the service provider does not have a contractual relationship with the insured (so there is no insurance transaction) and the essential aspects of being an insurance agent or insurance broker, being the finding of prospects and their introduction to the insurer, are not present (so the services could not be related services of the kind provided by an insurance broker or agent).

The UK's domestic law, which set the exemption wider, was therefore not in accordance with EU law. Recognising this incompatibility, HMRC issued a consultation on how the judgment could be implemented in UK law in July 2005. At a similar time, the European Commission announced its own review of the VAT treatment of financial services and insurance transactions with a view to modernising the exemptions. Because of this, the UK Government decided to postpone any changes to UK law until after the conclusion of the Commission's review. However, due to the inability to reach unanimous agreement across Member States, it has recently been announced that the modernisation project will not be pursued.

CJEU's decision in Aspiro

Consistent with its decision in Arthur Andersen, the CJEU has now decided in Aspiro that, in accordance with EU law, the insurance exemption must be interpreted strictly and that, although essential to the insurance product, claims settlement services provided by a third party in the name of an insurance company do not fall within either limb of the insurance exemption.

"Insurance transactions"

Following previous case law, the CJEU held that the essential aspect of an insurance transaction is that "the insurer undertakes, in return for prior payment of a premium, to provide the insured party … with the service agreed". This requires that contractual relationships exist between the service provider and both the insurer and the insured for the provision of insurance or the procurement of insurance cover for the insured. Although Aspiro corresponded with insureds, it only had a contractual relationship with the insurer and moreover its activities did not involve ensuring that the insured person was covered in respect of risk, and so its activities were not exempt under this limb.

"Related services performed by insurance brokers and insurance agents"

"Related services" is extremely broad and includes any services having a link to the provision of insurance, including claims settlement services. However, the scope of this limb is limited by the requirement that these services are of the type performed by an insurance broker or insurance agent. For this to be the case, the service provider must have a relationship (whether direct or indirect) with both the insurer and the insured and its activities must cover the essential aspects of the work of an insurance agent or broker, being the finding of prospective clients and their introduction to the insurer.

Although Aspiro satisfied the first of these conditions, it was not involved in finding and introducing clients and therefore its claims settlement services were not exempt under this limb.

Consequences for UK law

There has been some criticism of the CJEU's decision in Aspiro, with commentators considering that the decision does not take account of developments in the insurance sector. In particular, since the original drafting of the Principal VAT Directive, traditional insurance agents and brokers have been replaced to some extent by the emergence of other intermediaries which participate at stages other than the introduction of insurers to the insured, for example underwriting agents which act for the insurer in assessing risks, determining the premium to be charged, binding cover and issuing policies. The existence of multiple intermediaries and longer supply chains is a particular feature of the UK insurance market. However, the UK has never referred a case on this point and so the CJEU has not had an opportunity to consider the effect of its decisions in Aspiro and Arthur Andersen on the insurance industry, in particular that as a result of the decisions insurers will incur "cascading" VAT on outsourced services but will not be able to reclaim that VAT as they are making an exempt supply. Where there is a greater number of intermediaries in the supply chain, such as in the UK insurance market, the effect of input VAT being irrecoverable is multiplied.

Although Aspiro is a Polish case, the incompatibility of the UK domestic law is again in the spotlight. Given the impending referendum on the UK's membership of the EU, it is unlikely that the UK will address the mismatch between its domestic law and EU law immediately, however should the UK decide to remain a member of the EU, the scope of the insurance exemption in UK domestic law will need to be reviewed. Due to the desire to protect the UK insurance industry, the UK has always resisted this. However, with certain premium collection services no longer falling to be exempt under the financial services exemption, if the UK insurance exemption is narrowed to comply with EU law, insurance companies will be incurring more VAT on outsourced services. Even where the third party service provider is based overseas, a UK insurer would be required to operate the reverse charge and so incur VAT.

However, if claims are dealt with in-house, they are likely to constitute part of a single composite supply of insurance services, resulting in the entire supply being exempt, which may result in more insurance companies bringing their outsourced services in-house to minimise their irrecoverable input VAT. However, moving services in-house is likely to lead to costs on the transfer of employees under TUPE, and the recent trend has been away from the in-house market. This has not been a good month for the UK insurance industry, with an increase in the standard rate of insurance premium tax to 10%, effective from 1 October 2016, also announced in the Budget. Insurance companies, and all those involved in insurance, should watch next steps closely.