David Fownes assesses the implications for re/insurers of the European Court of Justice judgment imposing VAT on certain outsourced insurance services
The Judgment of the European Court of Justice in Arthur Andersen (C-472/03) was released on 3 March with the Court finding against Accenture with significant implications for the insurance industry including reinsurers, insurers, intermediaries/brokers and outsourcing providers.
The judgment has almost certainly restricted the scope of the VAT exemption for outsourced "insurance related" services, but the full implications of the case are still to be confirmed as HM Customs have indicated they will consult with the industry before implementing significant changes to UK VAT law.
It is to be welcomed that they resisted the temptation to rush changes through as part of the budget, but the probability remains that there will be an increased cost in the future to re/insurers where core insurance related services are outsourced. As such, re/insurers should be examining the potential impact on their business and re-evaluating their outsourcing arrangements.
Accenture provided a range of "back office" services to a Dutch insurance company, including handling and accepting applications for insurance or referring back to the insurer, issuing, managing and rescinding policies, making amendments to contracts and modifying premiums, receiving premiums, managing claims, setting and paying commissions to the insurers' agents, maintaining contact with agents and dealing with third parties, such as the tax authorities, on behalf of the insurer.
The ECJ has concluded that these "back office" services do not fall within the VAT exemption allowed in European law as they do not qualify as the "related services of an insurance agent or insurance broker".
The judgment is clearly not good news for the insurance industy and the VAT exemption for services such as back office/policy administration, run-off administration, claims handling, pensions/endowment reviews and even outsourced underwriting operations could be in doubt.
In making its judgment, the Court refers to the definition of brokers and agents in Art. 2 of Directive 77/92/EEC (a Directive concerned with freedom of establishment and not taxation) but does not explicitly state that these definitions should be followed in determining the meaning of the same words used in European VAT law.
The Court states that Accenture's back office administrative services "do not constitute services that typify an insurance agent". It also states that Accenture are not performing the "essential aspects of the work of an insurance agent", a clear example of which is cited as "the finding of prospects and their introduction to the insurer". This appears to suggest a restrictive scope to the exemption in that, unless an agent is actively involved in the sales process, it would not fall within the VAT exemption.
Although HM Customs have said they will consult widely, it is clear that they will be looking at back office insurance outsourcing and questioning whether it should still retain the exemption under current UK VAT law.
If an outsource provider is not actively involved in sales then they are clearly in danger of losing VAT exempt status. This would appear a harsh interpretation especially in respect of run-off agents and claims handlers who to date have always been firmly inside the UK definition of the related services of an insurance agent.
Any outsourced insurance administration service now has its VAT exempt status under threat and this will also affect any pension administration services. As the UK's pensions and savings industry is largely written as insurance contracts, this change could have a significant negative impact on personal savings if the VAT cost of administration is passed on to policyholders. No doubt this point will be brought out by lobbying groups during the consultation process but that does not mean HM Customs will be sympathetic to the outsourcers or their insurance industry clients.
It is worth noting that HM Customs believe that the scope of the current UK VAT exemption for insurance-related services has been interpreted too widely and they have been quite active in taking cases through the UK courts in respect of this. In most cases, HM Customs have lost and I expect they will be keen to use this judgment to overturn some of these UK court decisions.
As such, the industry needs to consider the likely increase in costs to outsourcing. In the UK, this will mean up to a 17.5% increase in costs on some outsourced services that are currently treated as VAT exempt. As cost is one of the primary considerations when insurance companies consider outsourcing such an extra tax cost could put a cloud over current and future outsourcing arrangements. Re/insurers are strongly advised to review current contracts to assess the impact on their business.
Lobbying during the consultation period will certainly be important as, although the judgment is clearly not favourable for the insurance sector, there is a fair amount of ambiguity in the decision. For example, the question of whether VAT exemption will apply where there is a chain of intermediaries in the sales process was not really answered.
The previous ECJ judgment in Taksatorringen v Skatteministeriet (November 2003, C008/01) had suggested that an insurance agent requires a relationship with both the insurer and policyholder in order to fall within the VAT exemption. This was very worrying for the UK industry in particular as the commercial practice is often to have a number of intermediaries in the sales chain particularly in the Lloyd's market.
As the judgment is not definitive on this point, it does give HM Customs the opportunity to be flexible and adopt a policy that is consistent with commercial practice. It would also make sense to adopt the same approach to chains of intermediaries whether that intermediary is seen as a broker (because it has a choice of insurers) or an agent (because it is tied to one insurer).
The judgment undoubtedly threatens the VAT exemption for any large scale back office outsourcing, especially where the outsourcing provider is not involved with the sales process.
However, there is a possibility that where an insurer has outsourced its back office operations to a non European Union (EU) location, eg India, that the judgment will not have the detrimental VAT impact (at least not in the short term). This is because, under the current EU place of supply rules, insurance administration services potentially can be deemed to be supplied where the supplier is based and therefore such services provided from India will be outside the scope of UK/EU VAT creating a potential competitive advantage over UK/EU outsourced operations. The Commission is looking to change these place of supply rules in the future and therefore the VAT advantage will not be long term.
For anyone with UK-based operations there are now significant concerns and great uncertainty, and re/insurers and providers of related services are strongly advised to be involved in the consultation process. HM Customs are expected to issue a business brief in April that will be the pre-cursor to a consultation period over the summer that will no doubt be followed by draft legislation.
It is important to note that current UK VAT law for insurance related services is largely based on the wording of the definition of agents and brokers in the Intermediaries Directive referred to above (Art. 2 of 77/92/EEC).
This Directive has actually been revoked and replaced by a new Directive on insurance mediation and therefore arguably UK VAT law would have needed updating in any case. The new Directive which was effective from January 2005 provides a clear definition of "insurance mediation" at Article 2 (3) - it "means the activities of introducing, proposing or carrying out other work preparatory to the conclusion of contracts of insurance, or of concluding such contracts, or of assisting in the administration and performance of such contracts, in particular in the event of a claim".
Clearly, if the judgment had indicated that the Directive dealing with insurance intermediaries should be definitive in determining the VAT exemption definitions then the use of "or" in Article 2 (3) would suggest that limiting the exemption to those actively involved in sales was far too restrictive.
Unfortunately, the judgment did not indicate as such but then neither did it dismiss the Intermediaries Directive completely. It could be argued that the new Directive on Insurance Mediation is actually very useful in describing the activities that typify an insurance agent and it remains to be seen whether the EU Commission and/or HM Customs could be persuaded to agree in the light of this judgment.
It is certainly something that should be raised during lobbying, as this Directive does reflect the commercial practice of the insurance industry in the EU as regards the activities of intermediaries.
If the Commission and HM Customs could be persuaded to take note of the definition within this Directive it is hard to see why the activities of a claims handling company or a run-off agent should not be allowed within the scope of the exemption, but whether there is enough ambiguity in the judgment to allow this must be in doubt.
In summary, this judgment is clearly a blow to the insurance industry but the full implications are not certain and there may be scope to define the landscape of the VAT exemption going forward. That scope is at its greatest now before any change to UK VAT law takes place and therefore the consultation period will be really important. We await HM Customs' business brief on this subject with great interest.
- David Fownes is head of the indirect tax insurance group at KPMG. insurance group.
Judgement of the Court (First Chamber)
Case C-472/03: Staatssecretaris van Financien v Arthur Andersen & Co Accountants cs
The Court ruled: "Article 13B(a) of Sixth Council Directive 77/388/EEC of 17 May 1977 on the harmonisation of the laws of the Member States relating to turnover taxes - Common system of value added tax: uniform basis of assessment must be interpreted as meaning that 'back office' activities, consisting in rendering services, for payment, to an insurance company do not constitute the performance of services relating to insurance transactions carried out by an insurance broker or an insurance agent within the meaning of that provision."