On 22 October 2020, the European Commission published an inception impact assessment for the review of the VAT rules for financial and insurance services, as announced earlier this year in the Action Plan for Fair and Simple Taxation Supporting the Recovery Strategy. The Commission is currently asking citizens and stakeholders to provide their views on the current situation, problems and potential solutions.

The exemption of financial and insurance services set out in the VAT Directive dates back to 1977, when VAT legislation was first enacted. Although the Commission attempted to review the rules in 2007, discussions in the Council did not bear fruit and the legislative package was withdrawn in 2016. As such, the rules remain outdated.

Entities providing VAT-exempt financial and insurance services are not entitled to deduct input VAT paid on their purchases or supplies received, thus making VAT a cost for those entities and, ultimately, for their customers and clients. This is one good reason for financial institutions to attempt to reduce the cost through strategies such as e.g. creating VAT groups or cost-sharing arrangements (the latter ended in 2017, as the Court of Justice of the European Union prohibited the practice in the financial and insurance sectors). Even beyond these observations, anyone familiar with the exemption recognises the complexity of the rules as well as the difficultly of applying them in practice. This is particularly true for financial industries that evolve quickly, such as fintech/insurtech sectors, an industry in which input services are being increasingly outsourced.

As a result, the Commission’s main objectives are to address the exemption’s adverse effects on the financial and insurance sectors and ensure the harmonisation of the VAT treatment of financial and insurance services across the EU Member States.

To address these issues, the following options are being considered:

• leaving the exemption rule unchanged
• eliminating the exemption and fully taxing financial and insurance services
• amending the scope of the exemption to tax only some types of services (e.g. fee-based as opposed to interest-based services)

According to the Commission, the removal of the exemption should eliminate the cost for both suppliers and customers of irrecoverable VAT associated with financial and insurance services. However, this outcome would only be achieved if some of the cost saving is passed on to customers through lower prices and this must be properly analysed from economic and commercial perspectives. Moreover, while this potential measure would entail an important simplification of the VAT rules, the benefits of this simplification have yet to be assessed given that, as indicated by the Commission, financial institutions have already implemented various measures and business models to reduce these costs. The limitation of the exemption would allow the adoption of tailor-made measures in response to the concerns raised in connection with the proposal’s impact on the sector, but it would also restrict the objectives pursued by the Commission.

 As to the initiative’s timeline, the evaluation and the impact assessment are currently underway. Public consultations should occur in the first quarter of 2021 and a legislative proposal will follow. Given the proposal’s importance for both sectors, financial institutions and insurers should pay particular attention to the results of the process.