Reviewing and optimising VAT recovery within the financial services sector as the Brexit transition period ends

With the end of the transition period on 31 December 2020 the UK financial services (“FS”) sector must prepare for life outside the EU’s single market on 1 January 2021.

Leaving the EU will have significant logistical, administrative, cost and tax implications for both UK and EU businesses.

The impact is not just limited to trade in goods but will also impact on the supply of services and this will particularly be the case with the FS sector. Leaving the EU will fundamentally alter the VAT status of supplies made between UK and EU counterparties. This will potentially result in the opportunity to significantly reduce the current level of irrecoverable VAT incurred on supplies made to EU counterparties.

Should an agreement on supplies of financial services fail to be concluded with the EU before 31 December 2020, certain supplies from the UK to EU will follow the same treatment as UK to non-EU customers which give rise to recovery on associated costs.

Our view is that FS businesses will need to consider a wide range of issues as part of their preparations for a no-deal Brexit. The key ones being as follows:

Significant scope for improved VAT recovery

Certain supplies of financial services provided to EU counterparties will no longer be exempt from VAT but will instead be outside the scope of VAT with credit.

In light of this we would recommend that FS businesses review their supplies to ensure that they will be able to maximise the VAT recovery advantages arising post-Brexit.

Are you incurring costs which are capable of being directly attributed to supplies of financial services to the EU?

These supplies are currently classified as exempt or partly exempt but to the extent that they are wholly attributable to qualifying supplies made to EU counterparties then full VAT recovery may be possible.

Can your systems cope with the reclassification of supplies?

Will your accounting system be able to deal with the changes in the VAT liability of relevant supplies made to EU counterparties post 1 January 2021? Are you able to comply with the digital links requirements which will apply from 1st April 2021 under the Making Tax Digital (MTD) regime?

Will your current method result in a “fair and reasonable” recovery of residual VAT following Brexit?

Post Brexit where you have an existing Partial Exemption Special Method (“PESM”) will this still result in a fair and reasonable recovery of residual input tax? Where input VAT recovery is significantly improved post Brexit it is possible that HMRC may be more inclined to review and where appropriate challenge the level of VAT recovery.

If appropriate you may want to consider submitting a proposal for a revised “PESM” to protect any enhanced VAT recovery and minimise the risk of a challenge from HMRC.

Have you reviewed key VAT bearing expenditure to determine if supplies can be procured in a more efficient manner?

It may be possible to achieve a higher level of VAT recovery by analysing expenditure and where appropriate agreeing revised contract terms to achieve a more accurate attribution of costs and where these are directly attributable to taxable supplies generate a higher level of VAT recovery.

Are you applying your existing partial exemption method correctly?

Have you conducted a VAT review of the existing partial exemption method? Are supplies made by and to the business reviewed periodically? In some cases it may be that certain supplies are not being treated correctly in respect of partial exemption calculations, leading to reduced VAT recovery and/or creating additional unknown liabilities.

Can you agree a revised partial exemption methodology which will improve the current level of VAT recovery either pre or post Brexit?

There are numerous options for agreeing a revised PESM which can potentially result in a higher recover of residual input tax. The challenge is to ensure that any alternative methodology applied for is not overly complicated and that you can demonstrate this results in a fair and reasonable recovery of input VAT.

Are your contractual terms ready for Brexit?

It is vital that FS businesses ensure that contractual documentation can deal with Brexit such that If changes to VAT legislation result in it being unprofitable for the business to continue to make/receive supplies, it is possible to exit the contract without penalties.

In circumstances where the parties disagree on the interpretation of the amended VAT legislation, the method for dealing with this disagreement should be clearly set out in the contract.

A review of the contractual teams does not always require the re-writing of contracts but rather clarifying or varying the relevant terms in existing contracts.

How can RSM help?

We can assist you in ensuring the businesses VAT recovery position is optimised post Brexit and where appropriate provide you with assistance with formulating an appropriate partial exemption methodology and making sure your systems are ready in advance of 1 January 2021.