A VAT Brexit gamble that you might like to consider?
This blog considers the right to reclaim VAT on costs associated with operating businesses in the financial service and insurance sector. If your business is not involved in these sectors then, academic interest aside, this is probably not for you.
If you had to make a guess on whether your business will be allowed to reclaim more VAT or less VAT if the UK leaves the EU without a withdrawal agreement what would you say?
If your guess is “It is likely that we will not be allowed to reclaim VAT post Brexit” perhaps now is the time to start preparing or take steps to lobby.
If your guess is “It is likely that we will be able to reclaim more VAT post Brexit” then you may still wish to consider whether there is something that you can do to make this more likely and maximize benefits.
I will say at the outset that the UK Government has been very non-committal on this subject. In its impact paper of 23 August 2018 it simply said:
For UK businesses supplying insurance and financial services, if the UK leaves the EU without an agreement, input VAT deduction rules for financial services supplied to the EU may be changed. We will update businesses with more information in due course.
This leaves businesses guessing – which is why I have spent some time looking at the factors that need to be weighed.
Setting the scene
Current rules
UK businesses can reclaim input VAT to the extent that the VAT bearing cost in question relate to “taxable” or “specified” supplies.
A “specified” supply is an exempt supply that is explicitly referenced in the VAT Specified Supplies Order 1999.
Only certain supplies of finance or insurance (and related intermediary services) are specified supplies based on the legal definition. Also, these services are only specified supplies when they are:
- provided to a customer outside the EU;
- directly related to an export of goods from the EU; or
- intermediary services relating to 1. or 2. above.
As a simplistic illustration if the supplies by a business are:
- 30% exempt services provided to UK customers;
- 30% exempt services provided to EU customers; and
- 40% exempt (specified) supplies to non-EU customers,
the businesses VAT recovery percentage might be 40%. Not an insignificant amount, for some perhaps the difference between making a profit or a loss.
Looking beyond Brexit
Under World Trade Organisation rules the tax policies of a member country must be nondiscriminatory.
Whilst the UK is a member of the EU (and the European Single Market) it is acceptable to apply different rules in the manner illustrated above. However, in a no deal Brexit situation, it would be discriminatory for the UK to allow a sale of services to a US customer to carry different VAT recovery rights than a sale to, say, a French customer.
This points to one of two approaches if the UK leaves the EU without an agreement, (or perhaps even if there is an agreement depending on its form).
- The UK could say sales of qualifying services to EU customers are “specified” supplies and carry the same VAT recovery rights as existing sales to non-EU customers.
- The UK could, with its escape from the strictures of the EU VAT Directive, adopt the policy “We will afford no rights of VAT recovery to sales of financial services to any customers” no matter where they are based.
If the Government takes the first approach then the level of VAT refunds to the business in the example above would increase from 40% to 70%.
If the Government decided to simply cease refunding input VAT to those engaged in financial services then the level of VAT refunds in the above example would fall from 40% to nil.
Your choices
- There will be an exit arrangement that keeps the status quo.
- There will be an exit arrangement that leads to increased input VAT recovery.
- There will be an exit arrangement that reduces VAT recovery.
Even if you think that you are likely to get the outcome you would prefer, now is the time to start lobbying if you are anything short of 100% certain.
There is also an immediate issue of how to price the potential outcomes into your business plans. A business that is currently reclaiming VAT in full because it provides only specified supplies could see its input VAT recovery fall to zero. Conversely a business that is currently making only EU supplies could see its VAT recovery rise from zero to 100%. In essence this has a potential impact of an 8% price rise or fall in respect of all VATable expenditure. This may be difficult to factor into contract prices.
Of course most financial service businesses will sit between these extremes and there are lots of additional complications – for example if new operations have been set up in another EU territory to ensure a continuing ability to trade, “What will be the VAT liability/impact as regards the provision of services from the residual UK operations to the new EU operation?”
Why did the Government make such a tepid statement?
The most obvious reason is that it really hasn’t decided what it will do – in which case it is certainly time to start lobbying!
A second reason is that it has decided what it intends to do and does not want to encourage businesses to adopt planning measures to circumvent any change. For example, if a business knew its VAT recovery rate would fall from 100% to 0% it might take steps to pre-empt the position and lock in a 100% recovery in respect of post Brexit costs, and vice versa (for example by delaying expenditure).
Pros of greater recovery restrictions
Blocking input VAT within the financial services and insurance sectors would:
- raise very large sums of tax at a time when most projections predict that the UK will be in desperate need of the money without breaking commitments given on other taxes;
- it would raise tax in a non-transparent manner. [It would be less visible to the electorate than putting up VAT, corporations or personal taxes];
- raise tax from a sector that does not engender a huge amount of public sympathy (the response of many voters would be “good!”); and
- lead to a simplification of rules.
Cons of greater recovery restriction
- It would impact on the competitiveness of the UK as a location from which to provide financial services and undermine the so called global economy benefit of Brexit. (Adopting the UK as a place of operations would be a huge disadvantage if businesses incurred, 20% irrecoverable VAT on many operating costs);
- In the long term it would adversely affect tax collection. It is only possible to collect VAT on transactions that are actually occurring. If the UK becomes a more expensive location to operate from then business will locate elsewhere.
The “forestall tax planning” motivation is also interesting. It is easy to see why the Government might want to delay a statement that restrictions will increase as there are measures that could be taken – some as simple as accelerating expenditure. However, if the Government planned to adopt rules that increased future recovery rights then the planning options would be more limited. Businesses could perhaps defer expenditure hoping to benefit from higher VAT recoveries or adopt planning structures. However, this seems far less likely.
The context of existing Brexit planning also needs to be considered. The standard approach is to:
- Pick an EU location to operate from and set up a subsidiary there;
- Transfer as little as possible to that location to obtain regulatory approvals, etc.
- Provide as many services as possible from the existing UK business to that new EU entity. This is easier than recruiting in large numbers and trying to inject local expertise (when the staff and expertise already exists in the UK).
EU regulators do not want brass plate operations within their territories and from the EU’s perspective “The more of a business that gets moved the better”.
The opposite is true from the UK’s perspective and the last thing it wants is to take measures that might accelerate that transfer of resources.
It seems obvious that in this context that the most sensible way of discouraging the migration of services from the UK is to say to financial service providers “Your VAT recovery rights will be increased if we exit the EU without an agreement”. So why is the government not saying this?
The “to discourage VAT planning” reason can surely be discounted as a trifling consideration looking at the big picture. Conversely, if the Government intended to apply greater restrictions to VAT recovery it might well want to avoid admitting it now. The planning option open to businesses would be greater and more obvious and perhaps, most importantly, a public statement to that effect might well increase the movement of operations to the EU as part of Brexit planning.
My guess is that Brexit will lead to “increased VAT recovery rights”. The simple logic for this would be “Surely the Government would not further disadvantage such an important part of the UK economy just as it is reeling from the other adverse impacts of Brexit”. However, I am now having doubts that I did not previously harbour. I keep coming back to the question “Why would the Government not say so if this was its plan?”
Your guess may have a lot of money riding on it. If the Government really has not made up its mind (or has made up its mind and simply doesn’t want to tell us yet) then those that need to should certainly be lobbying now. It is far more likely that a decision will be changed if the lobbying happens before it is announced.
As for the planning options, well that is a whole different book – a very large one. These range from the simple and almost impossible to challenge to the complex and less certain. I am certainly not an advocate of aggressive VAT planning and do not propose to change my views now. However, any business that has very large sums riding on these outcomes would be unwise not to at least consider its options. Some potential savings may have a lot more to do with complex legal arguments than any artificial structures. Preparing for and winning complex legal arguments is something that I approve of and that Constable VAT specialises in.