How does a taxpayer determine which of its supplies are exempt, which are taxable, and which are zero-rated or outside the scope of VAT?
This article begins with a cross-reference to the lists of services which qualify for exemption, and provides practical examples analysing different types of supply: loans, financial intermediaries, financial advice (mixed supplies) and shares. Finally, three recent real-world cases are summarised, highlighting how the courts apply VAT concepts to supplies in the financial services industry.
The first step is to identify which services qualify for the financial services exemption and which follow the normal rules.
There is a formal list of the financial services which qualify for exemption in the legislation (VATA 1994 Sch 9 Group 5, reflecting art 135 (1) (b)–(g) of the EC VAT Directive 2006/112/EC). HMRC’s interpretation of qualifying financial services is set out in Notice701/49.
Rather than dryly listing the exempt supplies given in the legislation and HMRC’s interpretations, this article will take the reader through common scenarios which show the basic principles in practice.
Example 1: Loans (and other supplies of credit)
A company lends money to customers. What are the VAT implications?
The supply of credit to a UK customer qualifies for exemption under VATA 1994 Sch 9 Group 5 item 2. A supply of credit is not restricted to loans.
A common example is an instalment plan, in which the customer pays more for the goods as a result of the cost of credit. The important VAT test for instalment plans is whether the charge for credit (e.g. interest) is separately identified. If it is, the supply of that credit is exempt. Otherwise, the supply of credit is not exempt and the consideration received from the customer will be taxed at the appropriate rate for the supply of the goods.
A more complex example arises if a separate finance company is involved. Expensive equipment can be purchased ‘on finance’ from retailers via an instalment plan. The package is often provided by a separate company. Careful analysis of the transaction is needed: the retailer might have supplied the equipment to the finance company (not to the customer), with the finance company making the final supply of both equipment and credit to the customer. This last point is important for business customers, who will need a full VAT invoice from the true supplier (i.e. the finance company, not the retailer) if they intend to claim any input VAT.
In the above examples, the customer belongs in the UK or elsewhere in the EC. In practice, it will be important to enquire whether the customer taking a loan from the UK lender belongs outside the EC. If so, the supply of credit would not be exempt, but would not be standard rated either. The supply would fall outside the scope of UK VAT (VATA 1994 Sch 4A para 16(2)(e)). The lender will still charge no VAT on the supply of credit, but it will also be entitled to recover input tax on related costs.
Example 2: Financial intermediary services
A company introduces a borrower to a lender. Can the company exempt its introduction services?
The supply of financial intermediary services can qualify for exemption under VATA 1994 Sch 9 Group 5 item 5. Intermediaries are more commonly known as agents, brokers or introducers, but the exemption is to be interpreted narrowly and note 5 helps to achieve this:
‘ ... “intermediary services” consist of bringing together, with a view to the provision of financial services,
‘(a) persons who are or may be seeking to receive financial services, and
‘(b) persons who provide financial services,
‘together with (in the case of financial services falling within item 1, 2, 3 or 4) the performance of work preparatory to the conclusion of contracts for the provision of those financial services, but do not include the supply of any market research, product design, advertising, promotional or similar services or the collection, collation and provision of information in connection with such activities.’
In this example:
- The borrower satisfies condition (a).
- The lender satisfies condition (b).
- The introduction was made for the purposes of a loan, which we know from example 1 qualifies as a financial service under item 2.
- Even if the loan is never finalised between the parties, the introduction was made ‘with a view to’ the provision of a loan and can therefore still qualify for the exemption.
- The difficulty in this example lies in the final part of note 5. We know that lending falls under item 2 and therefore preparatory work will be an additional test in this case.
What is preparatory work?
The EC VAT Directive 2006/112/EC refers to ‘the granting and the negotiation of credit and the management of credit by the person granting it’ (art 135(1)(b)). The introducer can therefore claim exemption if, as preparatory work, they negotiate terms between the lender and the borrower. In practice, HMRC accepts that helping a client to fill in an application form, checking it and forwarding it to the lender can qualify as preparatory work (VAT Manuals VATFIN7250), but excludes basic administrative and clerical work.
It is worth observing that, although intermediary services qualify for exemption under various headings in the legislation including item 6, the requirement for preparatory work does not apply to item 6. Intermediary services relating to item 6 (supplies of shares, stocks and other securities) are therefore exempt even without preparatory work. Perhaps less obvious is that exemption is not available for intermediary services relating to items 8 (bank accounts, etc.) or 9 (various types of investment management).
Once again, it is important to enquire whether any overseas parties are involved. If so, the company might have a valuable opportunity to recover input tax on related costs.
- If the intermediary’s client belongs outside the EC, the financial intermediary service is not exempt, but falls outside the scope of VAT. The intermediary will charge no VAT on its supply, but will also be entitled to recover input tax on related costs.
- If the client belongs within the UK or elsewhere in the EC, the financial intermediary’s services will be exempt. However, consideration should be given to the underlying financial service facilitated by the intermediary. If this underlying service is supplied to a customer which belongs outside the EC, the intermediary will be entitled to recover input tax on related costs.
Example 3: Financial advice and mixed supplies
What happens if a financial adviser provides financial advice to his client, then introduces a lender to that client and negotiates the terms of a loan?
In example 2, we found that the introduction service (with preparatory work) is exempt. Financial advice is not listed in VAT legislation as an exempt supply and should therefore be standard rated. However, one of the most complex issues in VAT at present is the concept of mixed supplies. The idea is that two supplies, which independently have different rates of VAT, together form a single supply with a single rate of VAT.
A significant recent change for financial advisers and intermediaries was the retail distribution review (RDR). Although VAT law did not change, HMRC rewrote its guidance in this area to recognise that the supply of financial advice and financial introductions were often a single supply from the customer’s point of view. HMRC considers the following example in its VAT Manuals (VATFIN7665), in which financial advisers:
- gather information about the customer (fact find);
- carry out research to find suitable investment options;
- provide the customer with reports, financial health-checks and forecasts;
- recommend specific investment products to the customer, including the prices at which these can be arranged;
- act between the product provider(s) and the customer with a view to arranging the sale of the retail investment products agreed with the customer; and
- where applicable, i.e. where the customer agrees to an ongoing review service, monitor the customer’s ongoing position to ensure that the products continue to meet the requirements of the customer.
Under the above circumstances, if all the services are supplied under a single contract and the adviser can evidence stages 1 to 5 (and 6 if appropriate), HMRC accepts that there is a single, exempt supply of financial intermediary services. Without stage 5, stages 1 to 4 would constitute a separate, standard rated supply of financial advice.
In effect, combining these five or six stages in a single contract converts a standard rated supply into an exempt supply.
This can be a valuable opportunity for those financial advisers whose fees are set by the market and whose customers (e.g. private individuals, banks, other intermediaries, etc.) cannot recover VAT charged to them.
Example 4: Shares (and other securities)
The exemption for financial services relating to the supply of shares (and other securities) is somewhat different from other financial services exemptions.
In example 2 we noted that no preparatory work is required for financial intermediary services to be exempt, if the underlying financial service is a supply of securities.
Many of the distinctions between the various kinds of financial services are rather subtle and a small change in the detail of a case can produce a significantly different VAT result.
The issue of new shares by a company is not considered to be a supply at all, according to the CJEU decision in Kretztechnik AG (C-465/03). Any costs related to the issue of new shares are treated as overheads for VAT purposes; input tax on such costs is recovered as residual input tax, subject to the restrictions arising from partial exemption calculations.
Overseas involvement is again important. From 1 April 2009, a key change occurred affecting those who supply securities and financial instruments to non-EC purchasers. From that date, all such supplies (known as ‘specified’ supplies) were ringfenced in partial exemption calculations. The idea is that residual input tax related to these ‘specified’ supplies would be apportioned between exempt and non-exempt supplies according to use (e.g. quantity of transactions), rather than value.
The effect is that overheads need to be apportioned between the ‘specied’ supplies and ‘other’ supplies. These overheads are then further apportioned within each limb of the calculation when considering whether the overhead expenses were consumed in making exempt or taxable supplies. A triple calculation results.
Recent cases illustrate the practical difficulties in determining the VAT position
There have been many cases over the years considering various aspects of the VAT rules relating to financial services. Such cases not only clarify the VAT rules in particular scenarios, but also illustrate the practical difficulties in determining the VAT position for supplies in the financial services industry. Some recent examples are summarised below.
Abusive arrangements: On 23 April 2010, the decision was released in the case of Paul Newey t/a Ocean Finance v HMRC  UKFTT 183 (TC). A company was incorporated outside the EC in Jersey, as a subsidiary of the taxpayer. It purchased advertising services from a local supplier free of VAT and it supplied financial intermediary services, also free of VAT, to lenders established in the UK.
HMRC argued that this was an abusive arrangement. Ordinarily, advertising services purchased from abroad would still attract a UK VAT charge, which could not be recovered by an exempt financial intermediary such as the taxpayer. The tribunal agreed with HMRC that the purpose of the arrangement was to gain a VAT advantage. However, in dismissing HMRC’s case, the tribunal concluded that this was not contrary to the purpose of the EC VAT Directive as the supply of advertising was made from Jersey (i.e. no VAT would be charged anyway), not from within the UK.
In contrast is the 1 May 2013 decision in WHA Ltd and another v HMRC  UKSC 24. Here, two companies had been established outside the EC in Gibraltar. Vehicle repair services, carried out under insurance policies, were charged to the Gibraltarian companies free of VAT. These Gibraltarian companies effectively resupplied the vehicle repair services, again free of VAT, to the exempt insurer in the UK.
Ordinarily, vehicle repair services would attract a VAT charge which could not be recovered by an exempt financial services provider, such as an insurance business. As in the Ocean Finance case, the Court of Appeal found that the taxpayer’s purpose in making these arrangements was to gain a VAT advantage. However, in this case, the supply of vehicle repairs originated in garages in the UK and the Court of Appeal ruled that a net UK VAT liability should have arisen.
As if to emphasise further the complexity of VAT considerations in the financial services industry, the Supreme Court agreed that a net UK VAT liability should have arisen, but for wholly different reasons: the repair services were provided by the UK garage direct to the UK vehicle owner, not to the taxpayer or the Gibraltarian companies.
Mixed supplies: On 19 July 2012, the CJEU issued its decision in the case of Deutsche Bank AG (C-44/11). The taxpayer took its own advice regarding the purchase and sale of securities, then executed those decisions as intermediary on behalf of its clients.
The CJEU reasoned that the two elements of the supply, although not ancillary to each other, were so closely linked as to be economically one supply which it would be artificial to split. The CJEU also distinguished the taxpayer’s service from exempt fund management services, on the grounds that a fund trades in its own name, whereas the taxpayer’s services were performed in the client’s name.
The CJEU decided that the taxpayer’s services were neither financial advice nor financial intermediary services, but a single supply of a third kind which did not qualify for exemption and was therefore taxable.
Financial intermediary services: On 13 June 2012, the decision was released for Bloomsbury Wealth Management LLP v HMRC  UKFTT 379 (TC). The taxpayer provided advice to its clients and then arranged for the clients’ money to be invested in funds. HMRC argued that, although fund management services are exempt under VATA 1994 Sch 9 Group 5 item 9, no exemption is available for intermediating between investors and fund managers (see example 2 above).
The tribunal discussed the issue of mixed supplies and concluded that the advice was ancillary to the taxpayer’s intermediary services (see example 3 above). It then noted that the customer’s aim was to purchase securities (VATA 1994 Sch 9 Group 5 item 6), rather than to be introduced to a fund manager. The tribunal concluded that the taxpayer’s services were intermediary between investors and the suppliers of securities, and could therefore benefit from the exemption.
Many of the distinctions between the various kinds of financial services are rather subtle and a small change in the detail of a case can produce a significantly different VAT result. It is, therefore, important to understand a taxpayer’s activity clearly before determining whether a supply falls within the financial services exemption.
This article was originally published in Tax Journal - May 2013