International Tax Dialogue Global Conference Session X VAT Treatment Of The Financial Sector: The EU Model and Experienc

1. International Tax Dialogue Global Conference Session X VAT Treatment Of The Financial Sector: The EU Model and Experience Rolf DIEMER Head of Unit DG Taxation and Customs Union D1: Value Added Tax and other turnover taxes European Commission International Tax Dialogue

2. Economic background Financial Services • are of central importance to our economy – in itself and as facilitator for ‘real’ economy • need to be competitive to offer the best contribution for growth and overall economic performance • Objective of truly European Financial Market (EU Financial Service Action Plan) • Apparently for many FS operators non-recoverable VAT single most important tax burden • PWC study: EU financial institutions are less profitable than their equivalents in other regions – VAT a reason? • Effects of financial and economic crisis – had VAT issues some influence? International Tax Dialogue

3. Traditional EU exemption • Traditional EU exemption model of the 6th VAT Directive: exempt financial services; tax certain fee-based services; zero-rate ‘exported’ services • It is more than30 years old and reflects an economic reality that no longer exists: • Deals only the operations which existed at the time, • Services were mainly local and rarely cross-border, • Cross-border flows/structures not significant, • Non-recoverability of VAT not so significant in the 1970s International Tax Dialogue

4. Unlike other VAT exemptions (e.g. health care) • no ‘social’ reasons • rendered in significant way also to other businesses • Exemption seen as short-term fix because of unresolved technical/practical difficulties in applying VAT to financial services, • how to identify and measure the value of financial services on a transaction by transaction basis, • tax recovery requires an invoice showing taxable amount and VAT at each level in the chain of activity International Tax Dialogue

5. Political sensitivity to change • likely to effect tax revenue from business (but is VAT intended to be a business tax)? • increase in credit charges or mortgages to consumer? (perceived problem, actual incidence unclear) International Tax Dialogue

6. Consequences of exemption • But exemption means: • tax cascading - non recoverable VAT enters into cost base, which over taxes business and under taxes consumers • bias towards vertical integration/self-supply which discourages outsourcing, favours organic growth over growth through acquisition • Complexity (notably pro-rata) • Distortions depending on customer status (under-taxation B2C and B2G; over-taxation B2B) International Tax Dialogue

7. Other possible effects: • may be an incentive to sourcing certain financial services from non-EU sources who do not suffer from imbedded tax, • compliance costs, • “sticking” tax accrues to State where service is generated, not where service is consumed • differences in application across EU Member States mean that no level playing field has evolved. International Tax Dialogue

8. Legal uncertainty • Without a definition (which reflects modern reality) of what constitutes “financial services” the scope of the tax is uncertain and inconsistent, • Borderline between taxable and exempt operations is often vague, • Rules on pro-rata are not clear and tax recovery rates vary significantly from one Member State to another, • Lack of clarity in the EU Directive, in the absence of any modernisation, has led to an increasing need to seek clarification through judicial means (e.g. on terminology: “negotiation”, “management”, “special investment funds”) International Tax Dialogue

9. Full taxation? • In principle full taxation = ideal (… and more ‘honest’ …) solution (no ‘social’ reasons for exemption), like for other commercial services • … but can the exemption simply be abolished? • ‘Truncated Tax Calculation Account’ (TCA) method (Satya Poddar) • Tested and shown to be workable • But perceived compliance burden and complexity dampened both business and TA enthusiasm. • Large consultation with EU business: TCA rejected International Tax Dialogue

10. On transaction-base there is still no clear and easy general way to define the tax base for many financial transactions • In some areas (e.g. consumer credit) taxation would politically not be feasible • Conclusion: full taxation is not an option, at this stage • … but new study by European Banking Federation to be published International Tax Dialogue

11. EU reform plans 2007 • New approach: find (limited) solutions to most urgent and most important problems • Legal uncertainty (definitions, different applications, ECJ rulings etc) • VAT as an obstacle to modern business structures (outsourcing, pooling, cost-sharing) • Lack of neutrality of VAT • VAT as a factor in competition with third countries (additional cost) • Lack of a European level playing field (uniform application of rules) International Tax Dialogue

12. Commission consulted on a number of possible avenues: • Zero rating • Review of exemptions (defintions) to extend/restrict their scope • Uniform limited input credit • Option to tax • [Allowing for cross border VAT bodies] International Tax Dialogue

13. Why not choosing zero-rating B2B supplies • Advantages: • For business, full recovery without output VAT, • Resolves misallocation of input tax, • Easily implemented. • Disadvantages: • Principle cost of eliminating the tax, • Conflicts with integrity of VAT system, • Distortive and conducive to inefficiencies, • Administratively complex, • Negative budgetary consequences. International Tax Dialogue

14. Why not extending the scope of the exemption • Advantages: • Deals directly with many issues associated with outsourcing, • Can be implemented in a way which reflects reality of today rather than 1970’s. • Disadvantages: • Difficult to deal with all scenarios, no lasting solution, • Legislation likely to be complex if disruption to existing ECJ jurisprudence is to be avoided, • Risk of continued case-by-case interpretation, • Possible equality of treatment issues, • May simply shift problems of non-recovery elsewhere in chain? International Tax Dialogue

15. Why not introduce a uniform input tax credit • Advantages: • Simple and known to work reasonably well in practice (e.g. RITC system in Australia). • Avoids need for case-by-case consideration, • By linking recovery to estimated wage element, is neutral between in-house and out-sourcing. • Disadvantages: • Possibly complexity; new dividing lines • Possible neutrality issues – but may have compensatory aspects, • Unlike AUS (e.g. labour) costs vary across EU – single composite recovery rate illusionary • Recovery rates in EU vary enormously between Member States and according to mix of activities which will make it difficult to agree a common base. International Tax Dialogue

16. ECJ jurisprudence - principles • Strict interpretation of exemptions in Article 13. Exemptions require definition at Community level and must be applied uniformly to avoid distortions of competition. • Nature of the service is important – not who supplies it. • Principle of fiscal neutrality must be respected. • Other Community rules for financial services and insurances start to become relevant when the Court cannot find clarity from 6th Directive. • The ECJ cannot construct a positive solution! International Tax Dialogue

17. Proposals (COM(2007)746 and 747 • Modernising the definition of exempt financial services and insurances via Directive and Regulation • Respecting limits of the current exemption • Ensuring that text better reflects the complexity and diversity of the modern industries • Including a regulation of application to detail and make directly applicable new definitions • Keeping as much as possible ECJ orientations (to use objective economic criteria to avoid concepts of national civil law) International Tax Dialogue

18. What has changed? • The wording of most exemptions • The distinction between financial and insurance service • Too many similar products offered by the different industries; increasing overlaps/substitutes (life insurance) • Requires new definition or insurance: risk related (economic approach) • A common concept of investment funds • regulated funds only? International Tax Dialogue

19. A new exemption for intermediation • A specific exemption for “partial” financial services • “supply of any constituent element of an insurance or financial service, which constitutes a distinct whole and has the specific and essential character of the exempt service” • change of the legal or financial situation of a party? • Specific interpretation rules as to complex services (insurance, credit) International Tax Dialogue

20. Are excluded from the exemption all services of a mere material or technical character such as • Compliance • general administration • IT software etc International Tax Dialogue

21. Financial services - derivatives • Derivatives • How and to which extent exclude contracts that may result in delivery of goods • Distinguish firm and optional commitments • Sufficient for raw materials? • Need for a definition? • How distinguish from betting? International Tax Dialogue

22. Cost-sharing • New exemption for cross border cost sharing arrangements • enable institutions to develop cost sharing and efficiency-driven consolidation without creating any new tax burdens • based on an existing concept (art 132 f of Directive 2006/112/EC) (ex art 13A par 1 f) • specific for financial services • cross border application within EU • to find solution to outsourcing issue (not via extension of exemption!) International Tax Dialogue

23. Conditions: • Group supplies services to its members • Members established or resident in EU • Group acts autonomously & independently • Member supply exempt services (or out of scope) • Services are necessary for the supply of exempt financial services • Reimbursement only of exact cost (except transfer pricing adjustment) International Tax Dialogue

24. Option to tax • Extending the existing option to tax these services which is currently at the discretion of Member States. • more general choice for all institutions/taxpayers, also for insurances, to reduce exposure to non-recoverable tax • EU-wide • no further detail which means available transaction by transaction, depending on operators capabilities • however, need for further implementing provisions (cross border issues) • therefore, entering into force only in 2012 International Tax Dialogue

25. Related issues • VAT grouping • VAT treatment of branch-to-branch transactions --------------------------------- • Alternative taxes on financial services as substitute to VAT? • Islamic Finance – VAT treatment? May be resolved by full taxation but also – incidentally – by clarifying exemptions? • Tax ‘imported’ financial services in future? International Tax Dialogue

26. Thank you for your attention Any question? Rolf.Diemer@ec.europa.eu European CommissionVAT and other turnover taxes - Taxation and Customs Union DG http://ec.europa.eu/taxation_customs/index_en.htm# International Tax Dialogue