VAT reform for financial services
VAT reform for financial services
There is significant momentum around updating the exemptions for financial services at an EU level. The current exemptions are outdated and lead to significant administrative and financial burdens for taxpayers across the EU.
In the past fifty years, there have been significant developments in technology and the nature of financial services offered, most notably decentralised finance (DeFi), crypto and fintech. Furthermore, although customer credit is exempt, the irrecoverable VAT incurred by financial services providers is indirectly passed on to consumers in a higher cost price.
Given the VAT exemption, EU Member States have sought to tax financial services in other ways, resulting in a scattered, unharmonised landscape. Currently there are 92 sectoral taxes levied across the various EU Member States, resulting in significant administrative and financial burdens for taxpayers.
The current legislative framework results in barriers to innovation, outsourcing and cross-border integration. These barriers have been more heavily documented in studies and reports in recent years. As a result, there is significant movement by both the European Parliament and European Commission with proposals to modernise taxation of the sector and reduce cross-border friction.
1. Modernising and simplifying the current VAT rules, whilst retaining the exemption.
This proposes:
In addition, given that VAT is derived from an EU Directive, all changes would require implementation at an EU level. For the changes to be passed, the legislation would be required to pass through all standard legislative steps, as well as unanimity in the EU Council.
Background
The current EU VAT framework for financial services dates back to 1977. At this time, a VAT exemption for financial services was proposed as there were significant technological difficulties in establishing the taxable base. In addition, the exemption was intended to have the effect of reducing the cost of credit to consumers.In the past fifty years, there have been significant developments in technology and the nature of financial services offered, most notably decentralised finance (DeFi), crypto and fintech. Furthermore, although customer credit is exempt, the irrecoverable VAT incurred by financial services providers is indirectly passed on to consumers in a higher cost price.
Given the VAT exemption, EU Member States have sought to tax financial services in other ways, resulting in a scattered, unharmonised landscape. Currently there are 92 sectoral taxes levied across the various EU Member States, resulting in significant administrative and financial burdens for taxpayers.
The current legislative framework results in barriers to innovation, outsourcing and cross-border integration. These barriers have been more heavily documented in studies and reports in recent years. As a result, there is significant movement by both the European Parliament and European Commission with proposals to modernise taxation of the sector and reduce cross-border friction.
Proposals
The proposals are split into three broad building blocks:1. Modernising and simplifying the current VAT rules, whilst retaining the exemption.
This proposes:
- modernising the definitions, including clarifying the distinction between technology (taxable) and financial (exempt) services, and
- simplifying and harmonising the deduction rules, by potentially introducing fixed deduction rates or optional / super-deduction rates
2. Reducing hidden VAT whilst retaining the exemption.
Ideas include expanding the scope of VAT grouping to EU-wide VAT grouping, as well as re-introducing cost sharing groups for financial services to help drive innovation and promote outsourcing. In addition, an option to tax could be introduced, potentially entity-wide or on a transaction-by-transaction basis.
3. More fundamental reforms, including:
- total removal of the exemption;
- removal of the exemption for fee-based financial services, but keep it for margin-based financial services;
- addition of new VAT rates;
- introduction of a Financial Activities Tax, and apply the zero VAT rate on services to which this tax applies.
The objective of the proposed changes is to provide more clarity to the VAT system and reduce the VAT burden on taxpayers and consumers alike.
Practical consequences
Although there is significant momentum and goodwill to adapt the VAT framework a European level, it will take a long time before any new legislation is finalised. Any changes to the VAT system would require significant and detailed analysis before implementation.In addition, given that VAT is derived from an EU Directive, all changes would require implementation at an EU level. For the changes to be passed, the legislation would be required to pass through all standard legislative steps, as well as unanimity in the EU Council.
