VAT treatment of financial intermediary services

A common area of concern for entities that act as intermediaries for financial transactions is whether their supplies fall within the VAT exemption for financial services. As innovation continues to reshape how financial services are delivered, businesses should ensure that the VAT treatment of their activities keeps pace with developments in the sector.

From a VAT perspective, the starting position is that services provided between UK businesses are subject to the standard rate of VAT (currently 20%) unless an exception applies. There is a VAT exemption applicable to certain supplies of financial services, and exempt supplies are not subject to VAT.

There is a cliff-edge difference between charging VAT and applying the exemption. As such, organisations often want their services to fall within exemption because their customers are frequently unable to reclaim VAT charged to them. Exemption can therefore help make pricing more competitive in the market.

It is important for intermediaries who have not previously considered the VAT implications of their services to review and clarify their VAT position.

What is a financial intermediary for VAT purposes?

There is a wealth of HMRC guidance and case law in this area that sets out the conditions that must be met for a provider of intermediary services to treat those services as a VAT-exempt supply.

The supply of intermediary services connected with financial services consists of bringing together, with a view to the provision of financial services:

• persons who are or may be seeking to receive financial services
• persons who provide financial services.

In order for the supply to be exempt, the party must be acting in the following capacity:

• as an intermediary in relation to an exempt financial transaction
• providing a service in relation to the exempt financial services transaction
• undertaking work that is preparatory to the conclusion of a contract for the provision of financial services.

A 'financial service' for the purposes of the intermediary exemption is a service listed in Schedule 9, Group 5, Items 1 to 4 and 6 of the VAT Act 1994. This includes the making of any advance or the granting of any credit and the issue, transfer or receipt of, or any dealing in, securities such as shares, stocks, bonds and notes.

Work preparatory to the completion of a contract refers to work of a specialised nature. This could include helping to negotiate the terms of a contract or making representations on behalf of a customer. However, it does not include work of a general nature such as administrative or clerical formalities.

HMRC continues to maintain detailed guidance on intermediary services within its VAT Finance Manual, reflecting the principles developed through UK and European case law. The VAT treatment of intermediary services has been the subject of a number of significant cases. In particular, the decision in CSC Financial Services Ltd established that exempt intermediary services must involve a distinct act of mediation in relation to a qualifying financial transaction. By contrast, supplies consisting merely of administrative, technical or clerical support services do not qualify for exemption.

Subsequent cases, including Bookit Ltd v HMRC and Cardpoint GmbH v Finanzamt Trier, have further reinforced the principle that simply arranging for, or instructing, another party to make a payment does not in itself constitute an exempt financial service. Whilst those activities may be essential to the overall transaction, they do not necessarily amount to the provision of an exempt intermediary service.

More recently, the First-tier Tribunal decision in Performance Leads Ltd v HMRC highlighted the fact-sensitive nature of the intermediary exemption. The Tribunal undertook a detailed review of the authorities in this area and considered the extent to which a business was genuinely acting as an intermediary, rather than merely providing marketing, advertising or conduit services. The tribunal held that the services should benefit from the exemption for financial intermediary services and the case serves as a reminder that the precise role performed by the supplier remains critical when determining the correct VAT treatment.

The primary takeaway from the case law is that organisations need to carefully determine the true nature of their supplies. Technology continues to change how financial services are delivered, but the application of the VAT exemption remains highly dependent on the underlying facts. Small differences in a business's activities can significantly affect both the VAT treatment of its supplies and the amount of input VAT it is entitled to recover.

Why does it matter?

Services that are exempt are not taxable for VAT purposes. This has two important consequences. First, VAT is not charged on the supply. Secondly, VAT incurred on costs directly attributable to the provision of exempt services is generally not recoverable.

Where an entity does not charge VAT on its supplies, it needs to be certain that the treatment is correct. If HMRC subsequently concludes that the supplies should have been taxable, it may assess the business for underpaid VAT.

The difference between charging VAT and applying the exemption can be significant. Where VAT is chargeable, the additional 20% can materially affect profit margins and pricing. It can also create unexpected costs for customers that make exempt or partly exempt supplies themselves and are therefore unable to recover all of the VAT incurred.

In addition to restricting recovery of VAT on costs directly related to exempt supplies, businesses that make both taxable and exempt supplies may need to carry out a partial exemption calculation to determine how much VAT incurred on overhead and residual costs, such as rent, utilities and professional fees, can be recovered.

Summary

One of the fundamental principles of VAT law is that exemptions should be interpreted narrowly. Failing to identify correctly whether services qualify for the financial intermediary exemption can therefore lead to significant and unforeseen VAT consequences.

The VAT treatment of intermediary services has been the subject of extensive HMRC guidance and case law, resulting in increased scrutiny of arrangements that seek to benefit from exemption. In our experience, businesses often meet some, but not all, of the relevant conditions, with the result that their intermediary services do not qualify for VAT exemption.

As financial services and fintech business models continue to evolve, organisations should regularly review the VAT treatment of their activities. Given the highly fact-specific nature of the rules, obtaining clarity on the correct VAT treatment can help avoid unexpected liabilities and improve pricing certainty.

For more information on the VAT exemption for financial services or partial exemption matters, please speak to your usual Crowe contact.