EU Tax Framework for the Financial Sector: European Commission publishes study on VAT reform
Tax Law | Legal Newsflash
The European Commission has published its long-awaited final report ‘Taxation of the financial sector’ which includes a comprehensive assessment of the European tax framework for banking, insurance and other financial services covering both the VAT exemption regime and national sectoral taxes. It identifies structural problems with the current framework and defines policy considerations ranging from targeted simplification to fundamental reform. The study delivers technical input for the policymaking process and adds to the momentum also created by the earlier introduced motion in which it was recognized that the current indirect tax landscape creates distortion in the financial markets.
Problems with the current framework
The study identifies two main problems in the production and supply of financial services.
Tax-driven distortions
Due to the VAT exemptions for financial services, providers do not have the right to deduct VAT. Hidden VAT on purchased inputs is not recoverable, which creates a fiscal barrier to outsourcing parts of the value chain. As the financial sector value chains have become increasingly complex and dependent on specialised providers, distortions have increased compared to previous decades.
Legal uncertainty, complexity and fragmentation
The VAT exemption and variety of sectoral taxes such as insurance premium taxes and stamp duties produce a fragmented and uncertain legal environment. Member States treat insurance-related services, fund and asset management, custody services, certain derivatives, payment value chains and some crypto-asset activities differently. Member States also take widely divergent approaches to the option to tax, VAT grouping and proportional deduction rules.
Policy reform
The EC has developed several building blocks to address all of this:
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Building block |
Policy considerations |
Key implications |
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Modernising and simplifying the current VAT rules while keeping the exemption in place by |
Modernise the definitions of financial services Simplify and harmonise the rules on proportional deduction |
Incremental improvements to legal certainty and compliance costs without addressing underlying distortion. Administrative cost savings ranging from EUR 95-450 million estimated. |
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Reducing hidden VAT while retaining the exemption |
Expanding or reforming VAT grouping and re-establishing cost-sharing arrangements for the sector, and making the option to tax available in all MS |
Significant reduction of hidden VAT possible, but at the cost of reduced VAT revenues. Cross-border VAT grouping and a broad transactional option to tax would reduce hidden VAT by several tens of EUR billion annually (e.g. EUR 570-670 million for mandatory VAT grouping). |
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Fundamental reform |
Remove the VAT exemption either for all financial services or only fee-based services, while services remunerated in the form of interest rates and other implicit charges would remain exempt or Introduce a Financial Activities Tax for all financial services, while zero-rating financial services for VAT purposes and removing sectoral taxes |
Administrative cost savings of EUR 920 million to EUR 1.3 billion. Revenue-neutral FAT scenario. |
Conclusion
The study concludes that the current tax framework causes distortions, complexity, legal uncertainty and fragmentation. It indicates that a fundamental change of the VAT framework for financial services is both warranted and practically feasible, with options ranging from full or partial removal of the VAT exemption to a replacement of the current regime through VAT zero-rating combined with a Financial Activities Tax. Targeted modernisation and simplification measures offer an intermediate path.
The Study is expected to form the backbone of an upcoming legislative initiative. Financial sector businesses that prepare early will be better placed to manage the transition. We recommend mapping hidden VAT exposure and assessing the impact on cash flow of potential changes to VAT grouping, and/or outsourcing.
Danny Stas
