CJEU: services supplied between an insurance group's headquarters and branches may be subject to VAT

The ruling on a dispute between Skandia's US business and the Swedish tax authority could have significant cost implications for banks and insurers operating in the EU member states through branch structures. Such businesses cannot recover VAT paid in the same way as businesses in other sectors as much of their business is VAT exempt. This treatment causes irrecoverable VAT on the cost base which can have an impact on the price at which financial products are sold to consumers.

To date, such businesses have not been impacted by VAT where charges are made between head offices and branches of the same legal entity. Globalisation has seen these businesses create geographically dispersed, but interdependent business models. The head office to branch 'carve out' has allowed charges for the effective "sharing" of personnel and infrastructure to be made without the imposition of VAT, said indirect taxes expert Darren Mellor-Clark of Pinsent Masons, the law firm behind Out-Law.com.

"Yesterday's judgment from the CJEU appears to be a genuine kick in the teeth for banking and insurance businesses as they contend with the enormous cost impact of complex changes required by international regulators", he said. "Modern financial services businesses involve intensive use of IT and communications technology. The increased VAT cost in this area alone could amount to hundreds of millions of pounds."

"By reaching this conclusion the EU would appear to be seeking to tax, in a potentially punitive manner, the globalisation process which, for so long, it has championed at a political level. The disincentive to future investment by these businesses could be significant. It will be critical to learn how tax authorities across the EU will seek to implement this judgment," he said.

The case stemmed from a decision by the Swedish tax authorities to charge VAT on the supply of IT services to Skandia's Swedish branch by its US parent company, Skandia America Corporation (SAC). The Swedish branch was a member of a single tax group of companies for VAT purposes along with other Skandia companies in Sweden, to which it passed on the supply of the IT services VAT free.

EU law allows member states to regard companies that are "closely bound to one another by financial, economic and organisational links" as a single entity for VAT purposes. However, the Swedish tax authorities had argued that the branch was a separate taxable person from the rest of the group, economically controlled by the US headquarters.

In its ruling, the CJEU agreed with this line of argument. It said that the Swedish branch did not carry out an "independent economic activity" as it did not operate independently; did not "bear the economic risks arising from the exercise of its activity"; and did not hold assets or capital of its own. Critically, however, because the branch was the member of a VAT group, the branch of the US company could no longer be treated as being the same legal entity as its US head office for VAT purposes. Rather the creation of the VAT group established a new entity, for VAT purposes, which was an amalgam of all its members. This meant that the supply of services from the US head office to its branch was now subject to VAT.

The CJEU also confirmed that it is for the recipient of those services to account for any VAT due rather than the supplier. "In those circumstances, and where it is also not disputed that the company which supplied those services is located in a third country and that it constitutes a separate taxable person from the VAT group, it is that group which, as the purchaser of the services ... is liable for the VAT," the court said in its judgment.

"In a situation such as that in the main proceedings where the main establishment of a company in a third country supplies services for consideration to a branch of that company in a member state and where the branch belongs to a VAT group in that member state, that VAT group, as the purchaser of those services, becomes liable for the VAT payable," it said.

"From a UK perspective this is very big deal," said Mellor-Clark. "Global financial services businesses have significant business hubs based in the UK. This judgment is likely to have a profound impact. The financial services industry will be holding its collective breath as to HMRC's implementation in general but in particular whether an element of retrospection will be aimed for."