New draft legislation could severely restrict VAT recovery by insurers

New draft legislation issued by HMRC could potentially impose very significant restrictions on VAT recovery by providers of certain 'insurance related' services, RSM has warned.

Under the current VAT recovery legislation, providers of 'insurance related' services such as insurance brokerage, claims-handling and policy administration can recover VAT on costs associated with their supplies, provided that the recipient of those supplies is based outside the EU. 

Examples of those who benefit include outsourcers who provide 'insurance related' services to non-EU insurers, non-EU insurers with associated claims-handling and policy administration companies, and insurance brokers with clients based outside the EU. 

Conversely, those who only undertake these types of transactions with UK and EU recipients are placed at a significant disadvantage in VAT recovery terms. As a result, insurers whose clients are predominantly UK-based, and those who provide “insurance related” services to them, obtain a significant VAT advantage where these services are channelled through a non-EU establishment of the insurer. Thus, no matter how innocuous the reasons for transacting with non-EU based parties are, HMRC has for some time felt the need to address this lack of ‘level playing field’ – even more so it seems, following the decision in the case of Hastings.

Commenting on the draft legislation, Justine McInnes, an indirect tax director at RSM said: 

'The extent to which this legislation will impact on providers’ VAT cost depends on the extent to which their client base is located outside the EU and the extent to which their client’s own customers are located in the UK. So there will be providers whose client base is mainly or wholly located outside the EU and whose VAT cost will therefore increase dramatically. Then there will be those whose client base is mainly or wholly located within the EU and who will see little if any change to their VAT cost.

'On the upside, the legislation could well eradicate the notorious “VAT inequity” which currently exists in this sector.  

'That said, the approach adopted by HMRC is, to say the least, slightly surprising. 

'First of all, on the face of it, the draft legislation is ultra vires of the EU legislation from which it is derived. Although this does not necessarily mean that HMRC cannot implement it, it is very likely that HMRC will have to apply for a derogation to do so. No mention of this application has been made in the notes accompanying the draft legislation or it seems, elsewhere.

'Secondly, given the relatively short time period within which it is envisaged that the draft legislation will be implemented, it is surprising that no mention is made in the draft legislation or accompanying notes, of any transitional provisions. 

'Finally, the draft legislation is very broad; many transactions with non-EU counterparties are structured for commercial, regulatory or other reasons rather than VAT avoidance. This however, does not appear to be reflected in the legislation.

'Given the above, there may be those who wish to satisfy themselves of the validity of any legislation which is implemented prior to making any changes to their VAT recovery – particularly where a “cost/benefit” analysis of the merits of this approach has been undertaken.

'In any event, there are still a number of very effective, non-aggressive VAT cost reduction strategies for those who provide “insurance related” services. These should now be explored on a case by case basis, in conjunction with the business’ transaction profile and corporate structure. This will enable these providers to determine the optimum way forward if and when valid legislation is introduced which curtails their VAT recovery.'