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. Over the last few years, the financial services industry has undergone a big transformation and this year has seen a number of new organisations in the fintech space ranging from cryptocurrency exchanges to peer-to-peer lenders.
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 the exemption. As such, organisations often want their services to fall within exemption as frequently their customers are unable to reclaim VAT charged to them, and also so that its pricing is more competitive in the market.
It’s important for intermediaries who haven’t considered the VAT implications of their services to review and clarify their VAT position.
There is a wealth of HMRC guidance and case law in this area that sets out the conditions that are required to be met in order for a provider of intermediary services to treat its 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:
In order for the supply to be exempt, the party must be acting in the following capacity:
A ‘financial service’ for the purposes of the intermediaries’ exemption is a service listed in the VAT Act 1994, Schedule 9, Part II, Group 5, items 1 to 4 and 6. This includes the making of any advance or the granting of any credit and the issue, transfer or receipt of, or any dealing with, any security including shares, stocks, bonds, notes etc.
Work preparatory to the completion of a contract refers to work done of a specialised nature. This could include helping to set the terms of the contract or making representations on behalf of a customer. However, it does not include work done of a general nature such as administrative or clerical formalities.
The VAT treatment of intermediary services has been the subject of high-profile VAT case-law in the case of CSC Financial Services Ltd. The main points from the case were that the services provided must have the effect of altering the financial and legal situation between the parties involved. If the supply involves a mere physical, technical or administrative service that does not alter the financial or legal status of the parties, it is not covered by the scope of the exemption.
Further cases (Bookit Ltd v HMRC, and Cardpoint GmbH v Finanzamt Trier) suggest that the necessity for intermediary services to alter the financial and legal situation of the principals may be more restrictive. The CJEU held that simply arranging for, or instructing, another party to affect a payment, whilst essential, does not in itself qualify for exemption.
The primary takeaway from case law is that organisations need to determine the nature of their supply to confirm exactly what services are being provided. Technology is altering how financial services are being provided and the VAT law is yet to catch up with modern technology and activities. The application of the VAT law concerning financial intermediary services is very fact specific, meaning that small differences in a business’ activities can affect the VAT treatment of its supplies and what amounts of VAT it can reclaim.
Services that are exempt are therefore not taxable for VAT purposes. This has two effects; firstly, VAT is not charged on the services and secondly, VAT incurred on costs directly related to the provision of exempt services is not eligible for recovery.
Where an entity does not charge VAT on its supplies, it needs to be certain that the treatment is correct otherwise it could lead to HMRC assessing for underpayment of VAT if it does not agree with the treatment. There is a stark contrast between charging and not charging VAT. Where VAT is chargeable, the added 20% is a significant amount that can erode profit margins. It can also mean unexpected costs for the recipient of the service, especially if they are exempt (or partly exempt) and cannot recover the VAT on their costs.
In addition to blocking VAT recovery on costs directly related to an exempt supply, where an entity makes both taxable and exempt supplies, it would need to consider carrying out a partial exemption calculation in order to recover a proportion of the VAT on overhead or residual costs such as rent, utilities, professional services etc.
A principle of VAT law is that the financial services exemption is applied narrowly, and by failing to identify whether or not your services are VAT exempt can lead to unforeseen VAT consequences.
The VAT treatment of intermediary services has been the subject of high-profile VAT case-law which has led to increased HMRC scrutiny on the treatment of such services. In our experience, entities often meet some but not all of the conditions highlighted above and therefore the intermediary services cannot be treated as a VAT exempt supply.
With more intermediaries entering the fintech space, it’s important for those who haven’t considered the VAT implications of their services to carry out a review and clarify its VAT position.
For more information on VAT exemption on financial services or partial exemption matters, please speak to Robert Marchant, or your usual Crowe contact.
How does VAT apply to cryptocurrencies and NFTs?
The Partial Exemption Special Method (PESM)
Digital training and events – Getting the VAT right
VAT: Agent vs Principal