Cross border VAT and the slow death of offshore financial services outsourcing

Opinion

Cross border VAT and the slow death of offshore financial services outsourcing

Value added tax is a consumption tax levied on any value that is added to a product or a service. The concept (invented by the French) was first introduced in that country in 1957 and by now dealing with VAT is routine, not only in France but throughout Europe and Asia (where it is generally named GST), writes Jean-Louis Bravard, director at outsourcing benefit collection specialist Burnt Oak Partners.

So why bother writing an article on VAT?

First of all, it is important to be reminded that the key concept in VAT is that personal end-consumers of product and services cannot recover VAT on purchases but businesses are able to recover VAT on the materials and services that they buy to make further supplies or services sold to end-users.

This rule is slightly misleading as in reality businesses only recover VAT in full if they themselves add VAT to the services they sell. Traditionally that has been a problem for banks and insurance companies because historically the bulk of their services have been VAT free.

The world is about to change... from 1 January 2010.

Nothing changes for consumers, who will continue to feed the state machine. However, things will change for businesses for any good or service they transact cross border.

The current practice of charging the exporter's VAT rate (or exporting VAT free) will now be reversed, which means that a UK business buying a French product will now be levied the relevant UK VAT rate, not the French.

The first impact is that selling across borders is now going to be far more complex as each exporter will need to know tax rates in 27 countries versus one before and more importantly the rules for VAT will make a dramatic impact on non EU sales into the EU.

The problem, especially for banks and insurance companies, is that since VAT was first introduced they are now far more international and rely far more on outsourcing.

Taking an Indian supplier providing BPO services to a UK bank as an example, today the VAT rate is zero but from 1 January 2010 the services will be taxed at 17.5% (assuming the rate returns to that as announced). In a normal business, that would potentially generate a cash-flow issue (between payment and collection of VAT) but in the case of banks only a portion of the VAT is recoverable. A bank with only interest income and no VAT bearing fees would have to pay 17.5% of its Indian bill to the Inland Revenue.

In financial services, VAT issues are not new and various solutions were found to diminish or altogether avoid VAT issues when outsourcing services. BPO offered the argument that VAT should not be levied when an internal process (VAT free) was moved to an external provider using the same employees via a TUPE transfer. If my reading of the new rules is correct, VAT issues remain unchanged within the same country but arise anew even if the service provided is intra-company from a subsidiary (no matter the percentage ownership) located somewhere else in the EU. (My assumption is that intra-country any extra VAT cost may be negotiated away).

There seems to be no scope within the EU directive for companies headquartered in one EU member state to be treated as VAT grouped so that cross charges within the group can be VAT free. While this creates tremendous complexity for most companies, the impact on financial services could be significant.

For example, a UK based bank with an asset management back office in Ireland or Luxembourg will now incur VAT (at the 17.5% rate from 1 January 1 2010) whether it is a subsidiary or has outsourced to a BPO supplier, European or not.

In conclusion, I see three main impacts:

  • The first obvious difference between previous years and 2010 is that tax revenue will most certainly go up as a lot of previously VAT exempt services will now be taxed and not all VAT will be recoverable. This is a stealth tax on financial services and will probably not lead to a mass protest by consumers as taxing banks is a recurrent leitmotiv in the press.
  • The second difference is that within the EU we will now have a level playing field. Services whether provided from inside the EU or the rest of the world, will now be subject to the reverse charge, whether provided by a third party of within the group. In other words, any service provided to a UK company from any location will incur VAT at 17.5%. Simple isn't it?
  • The third issue is for existing outsourcing services contracts. Which party will bear any cost increase? Take the example of an Indian company with a Luxembourg European headquarters reinvoicing BPO services to a UK bank. Assume that the bank recovers only 20% of the VAT it pays, then, from 1 January 2010 the true cost goes up by 14% and this may wipe out a substantial part of the saving generated by the move of the supply to Mumbai.

For a very clear description of the changes I recommend the UK tax authority website.

For analysis and views on the impact on outsourcing, I found Berwin Leighton Paisner to be the most informative.

For more information, see www.burntoak-partners.com

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This was first published in December 2009

 

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