Why the EU’s VAT exemption on insurance and financial transactions may need revising

Current VAT rules on financial and insurance services in the EU have long been criticised for being too complex and for having fallen off the pace of the sector’s latest developments.

The lack of VAT neutrality, the legal uncertainty and the ensuing high administrative costs stemming from the existing rules have recently led the European Commission to launch a citizens' initiative to propose new/amended VAT EU legislation. The public consultation phase has just closed.

While waiting for the Commission’s feedback, one should reflect on the many issues that have been raised about the current solution.

Some criticise the fact that most financial and insurance services are VAT-exempt, which could bring about cascading VAT in the supply-chain and an unnecessary VAT burden. This flouts the fundamental principle of VAT neutrality within a business-to-business (B2B) context and increases the cost of EU financial services, whose providers are therefore less competitive than their US (and after Brexit, also British) counterparts (the UK has announced their intention to allow deduction of input VAT attributable to financial and insurance services).

Others argue that the VAT burden is so significant that it influences commercial decisions due to the outsourcing bias and costly compliance obligations.

Other issues worth mentioning include that Article 135(1) of the VAT Directive requires member states to exempt insurance and financial transactions, without accurately defining the scope of the exemptions and provides little to no criteria on how to work around the lack of legal definitions for the terms laid down in the legal provisions. Directives 2004/39/EC) r 2016/97/EC could arguably offer some guidance, but fall short of making up for the VAT Directive’s shortcomings.

In the absence of the legislative progress, the ECJ’s case law can be considered. As case law focuses on specific cases, this is a drama in four acts: case law offers no legal certainty, gives a quasi-legislative role to the court, does not ensure consistent harmonisation, and therefore further contributes to the distortive effects of the VAT exemption and to divergent judgments regarding the same legal provisions.

Cases such as Aspiro (C‑40/15), and many others, are a case in point.

Aspiro was a third-party service provider responsible for handling the claims of an insurance company. A request was lodged for an individual written interpretation of the law, to establish whether Article 135(1)(a) should be interpreted to mean that the services were covered by the exemption when supplied by a third party in the name and on behalf of the insurer, and without any legal relationship with the insured person.

Article 135(1) of the VAT Directive states that insurance and reinsurance transactions, including related services performed by insurance brokers and insurance agents are VAT-exempt, but it does not define broker, agent or related services.

The ECJ ruled that the handling of claims by a third party like Aspiro, without the outsourcing being linked to finding prospective clients and introducing them to the insurer to execute insurance contracts, was not VAT exempt.

This decision confirmed that the scope of the exemption for insurance and related services is narrower than the scope defined for other financial services, in the sense that the broad scope of other financial exemptions to outsourced activities does not extend to insurance. The insurance exemption for ‘related services’ is limited to ‘insurance agents and brokers’ strictly defined by law.

However, since the specific legislation defining agents and brokers is modomestic, should that legislation go beyond the strict EU position, there might be room to broaden the scope of the exemption, which could raise issues of non-harmonisation among member states.

Until the VAT Directive is amended and reviewed, which may be happening soon, it is relatively fair to say that the VAT legislation’s lack of clarity and ability to address its many scope-related issues continues to bring about or contribute towards distortions within the single market.

Mariana Rapoula

Consultant, Lobo Vasques

E: mariana.rapoula@lobovasques.com