TEI files comments with the European Commission on modernizing the VAT obligations of financial services and insurances.
On 11 May 2006, the Directorate-General Taxation and Customs Union of the European Commission released a Consultation Paper on modernising Value Added Tax obligations for financial services and insurances. The purpose of the consultation is to generate feedback on possible options for changing the provisions in the Sixth VAT Directive and to provide input for discussions with stakeholders. On behalf of Tax Executives Institute, I am pleased to submit the following comments.
TEI was founded in 1944 to serve the professional needs of business tax professionals. Today, the organization has 53 chapters in North America, Europe and Asia. As the pre-eminent international association of business tax professionals, TEI has a significant interest in promoting tax policy, as well as in the fair and efficient administration of the tax laws, at all levels of government. Our 6,000 members represent 2,800 of the largest companies in the United States, Canada, Europe, and Asia. In 1999, TEI chartered a chapter in Europe, which today encompasses employees of a wide cross-section of European and multinational companies. TEI members are accountants, lawyers, and other corporate and business employees responsible for the tax affairs of their employers in an executive, administrative, or managerial capacity. The Institute espouses organisational values and goals that include integrity, effectiveness and efficiency, and dedication to improving the tax system for the benefit of taxpayers and tax administrators alike.
Since July 2000, the European Commission has been reviewing various proposals in the value added tax (VAT) area. The most recent Consultation Paper identifies various issues arising in the insurance and financial services businesses and discusses the advantages and disadvantages of alternatives for modernising the Value Added Tax provisions.
TEI commends the Commission for undertaking the consultation process. Although the primary focus of the paper is the insurance and financial services businesses, any changes in the Sixth VAT Directive will affect potentially every business that provides supplies to financial services companies, consumes financial services, or makes auxiliary supplies of financial services in connection with its principal business. In sum, every business, large or small, public or private, has a stake in the modernization of the Sixth VAT Directive.
The Consultation Paper catalogues a number of VAT issues that contribute to distortions in the manner in which financial and insurance businesses structure their activities. Specifically, distortions are created by:
The outdated nature of the VAT rules. The provisions in the Sixth Directive addressing financial and insurance services have not been amended since the Directive was adopted in 1977. Consequently, the Sixth Directive has not kept pace with the evolution in financial markets, products, and the manner in which financial and insurance services are delivered. Moreover, the rules do not reflect contemporary business trends and practices such as globalisation, outsourcing, and offshoring.
Conflicts between the VAT legislation and regulatory provisions governing the financial services industry in the Member States of the European Union (EU).
The lack of uniformity among the Member States in respect of the VAT legislation applicable to financial services and insurance transactions.
Inconsistent (or non-) application by Member States of decisions of the European Court of Justice (ECJ) relating to the VAT rules for financial and insurance services transactions.
As a result, similarly situated taxpayers and economically equivalent transactions are not treated uniformly or consistently by the Member States. The lack of uniformity and consistency, in turn, produces significant legal uncertainty and administrative burdens for taxpayers and Members States alike.
In addition, although the underlying premise of value-added consumption taxes is that the tax cost should be passed through to the ultimate consumer and thus be a neutral factor in business-to-business (B2B) transactions, VAT is often a major cost in finance and insurance businesses because of the provision of internal services within a corporate group operating in a parent-subsidiary structure rather than in a head-office and branch structure.
Finally, since financial and insurance services are exempt from VAT, limits on the recovery of VAT on taxable input costs encourage vertical integration of financial services and insurance businesses. Hence, financial institutions are inhibited from outsourcing non-core functions (e.g., data processing, managed information technology services, or other back-office operations) to improve their operational efficiency.
In order to ensure consistency in the treatment of similarly situated taxpayers and economically equivalent transactions, and thereby increase the certainty of the legal results for all taxpayers and ensure a level playing field for all businesses across the European Union (EU), TEI urges the Commission to consider the following recommendations and measures in respect of the application of VAT.
1. The current rules, especially those governing VAT exemptions, should be revamped and updated to reflect modern financial and business terminology, usage, and practices. For example, the definition of exempt services in Article 13 B (a) and (d) of the Sixth Directive was adopted in 1977 and thus reflects the financial services and products that were common at that time. Hence, taxpayers and Member States face difficult interpretation issues when applying outdated definitions and terms to contemporary financing transactions. Updating the language will aid in determining the tax liability and place of supply.
2. The VAT rules applicable to the heavily regulated financial services sector should be aligned and harmonised with the regulatory provisions.
3. The Commission should promote greater uniformity in the VAT legislation among Member States, especially in providing clear definitions of exempt supplies and in specifying the manner of recovery of input tax related to exempt supplies. To enhance uniformity across the EU in respect of these critical provisions, Member States should be encouraged to look to, and model their rules after, the VAT legislation adopted by Member States with mature financial services and insurance markets.
4. Greater flexibility in the manner of recovery of input tax costs should be afforded to businesses that are not fully taxable. For example, TEI recommends that the Commission encourage all Member States of the EU to adopt the special method under Article 17(5) of the Directive. This is the current position in the United Kingdom, which permits businesses to employ a range of apportionment methods. The different options allow businesses to apply the method that best reflects their specific business conditions.
5. The European Commission should work to ensure that the rulings by the European Court of Justice (ECJ) interpreting VAT legislation are applied uniformly within the Member States. Regrettably, certain decisions, such as that in the SDC case (1) affecting payment processing services, are applied inconsistently.
6. Legal-form and corporate-structure driven VAT costs, which arise through internal centralisation of services especially in financial and insurance service businesses, should be minimized by permitting cross-border grouping structures for VAT purposes or by implementing special rules that treat legal-entity to legal-entity transactions in the same fashion as branch-to-head-office transactions. In other words, VAT should not be charged on internal transactions within a controlled group of affiliated companies.
7. VAT costs associated with outsourcing of services by the financial services sector can be mitigated by the adoption of reduced input tax credit rules for supplies of such services. The adoption of such rules would reduce the disincentive that VAT creates when banks or insurance companies are comparing the cost of third-party service providers with internal labour costs. Hence, the Commission should consider recommending adoption of the Australian Reduced Input Tax Credit model, which permits recovery of 75 percent of the Goods and Services Tax (GST) on the specified services. The other 25 percent of the GST on input costs is subject to the normal recovery rules.
8. Where a bank or insurance company supplies an exempt service (e.g., credit), it cannot fully recover the VAT on the cost of its supplies. Under Article 17 only the VAT incurred in taxable transactions is deductible. Hence, taxable businesses that consume exempt financial services often suffer a hidden VAT cost because the supplier must recover such costs in its profit margins. Hidden VAT costs can be eliminated by zero-rating B2B supplies or affording taxpayers an option to tax B2B transactions. Under an option-to-tax method, the complexities of selective taxation of financial and insurance transactions would need careful consideration to ensure that the rules were easy to understand and apply.
9. Distortions in VAT recovery can also arise where a fully taxable business makes an auxiliary exempt supply, e.g., a manufacturer makes a loan to an affiliate. The ECJ decision in EDM (2) clearly states that the grant of an intercompany loan is of an auxiliary nature and is not part of the taxpayer's primary business activity. Such auxiliary transactions should not affect the company's VAT recovery. Some Member States, however, do not apply the EDM decision and hence the auxiliary transaction will affect the input tax recovery ratio of otherwise fully taxable persons. The failure of such Member States to follow the EDM decision violates the neutrality principle of the Sixth Directive. Distortions in the recovery of VAT can also arise where a fully taxable person is involved in other auxiliary transactions such as cash pooling activities (3) or selling shares (where such sales are outside of the principal commercial activities of the business). (4) Neither of these activities should have an effect on the input VAT recovery position of a fully taxable business, but the rules and practices of the Member States are inconsistent in ensuring this tax treatment.
10. The VAT rules applicable to supplies of financial services outside of the banking and insurance sector also vary widely across Europe. For example, some Member States treat the entire amount of a lease payment as subject to VAT whereas other Member States treat the capital portion of the lease payment as taxable and the financing element as exempt. Suppliers are then required to allocate input tax to the respective elements to determine the deductible amount of VAT. The complexities and burden of allocating the VAT between exempt and taxable elements grow substantially with cross-border leases, which may be treated as a supply of goods in one jurisdiction and a supply of a service in another. The place and time of supply rules do not fully address such transactions. As a result, depending on the structure of the transaction and the location of the parties, there may be multiple or no taxation of lease payments. The lack of uniformity in the rules governing the treatment of such transactions again imposes significant compliance burdens and creates legal uncertainties for taxpayers. Although leasing transactions are beyond the scope of the current Consultation Paper, we urge the Commission to consider this topic as it continues its review of the VAT rules.
TEI believes that adoption of the foregoing recommendations will promote a level playing field for businesses across Europe and minimise inconsistencies in the treatment of similarly situated taxpayers and economically equivalent transactions. By ensuring the uniform and consistent treatment of taxpayers across Europe and increasing the legal certainty of the tax results of business transactions, the Commission will enhance the competitiveness of European businesses and promote growth in the European economy. TEI fully supports the Commission's efforts.
Tax Executives Institute appreciates this opportunity to present our views on the Consultation Paper on modernising Value Added Tax obligations for financial services and insurances.
These comments were prepared under the aegis of TEI's European Tax Committee whose chair is Guy A. Kersch. If you have any questions about the submission please contact Mr. Kersch at 352.26.09.09.39 (guy. email@example.com) or Jeffery P. Rasmussen of the Institute's legal staff at 1.202.638.5601 (firstname.lastname@example.org).
(1.) Case C-2/95, Sparekassernes Datacenter (SDC) v. Skatteministeriet (5 June 1997).
(2.) Case C-77/01, Empresa de Desenvolvimento Mineiro, SA v. Fazenda Publica (29 April 2004).
(3.) Cash pooling involves a balancing of cash shortages and surpluses among members of a group of companies, thereby creating temporary intercompany loans.
(4.) In the Kreztechnik decision (Case C-465/03, Kretztechnik AG v. Finanzamt Linz (26 May 2005)), the ECJ confirmed that VAT incurred in connection with the issuance or sale of shares of a company is fully deductible if the issuer is fully taxable.
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|Title Annotation:||Tax Executives Institute, value added tax|
|Date:||May 1, 2006|
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