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VAT demands issued to UK branches of non-UK financial services companies

ANALYSIS: Businesses in the financial services sector that outsource group functions to a non-UK group company with a UK branch could face multi million pound VAT challenges.17 Oct 2018

The UK's HM Revenue & Customs (HMRC) has started issuing multi-million pound VAT assessments to financial services businesses that outsource group functions to an overseas group company with a UK branch. 

The principles relied on by HMRC in support of their position are controversial. The impact on affected businesses is likely to be significant because an adverse ruling from HMRC could have both retrospective and prospective effect.

Insurance companies and banks are unable to recover a significant amount of the VAT which they incur on services supplied by overseas group companies, which are often located in India or the US. 

This irrecoverable VAT can be mitigated if the overseas company establishes a branch in the UK, and that branch, and therefore the overseas company, joins the UK VAT group, with the effect that supplies between VAT group members are disregarded for VAT purposes. 

Such a model can operate to save the group large sums of money each year and HMRC has started to take an interest.

HMRC is challenging the arrangements which it considers lack the necessary substance, such that the branch does not constitute a UK 'fixed establishment'; or exercising their 'protection of the revenue' powers, where they believe the fiscal benefit to the group outweighs the administrative benefit of VAT grouping.

All businesses operating the referred outsourcing model should conduct a review of their current arrangements to determine whether a current or prospective UK branch is at risk of being terminated or rejected from the VAT group membership. They should consider what steps could be taken to reduce the risk of an HMRC challenge in the future.

If HMRC has already been in contact, it is important that the company obtains early strategic and practical legal advice on how to manage its possible risk exposure.

The potential financial consequences for businesses in the banking and insurance sectors are significant. This is in part due to the potential for HMRC to terminate VAT group membership retrospectively, and seek payment of VAT that would have been due if the UK branch had not been part of the VAT group, typically for a period of four years.

It is important that businesses have a clear understanding of what the concepts of 'fixed establishment' and 'protection of the revenue' mean in practice. Affected businesses need to have an understanding of HMRC’s interpretation of these concepts, but also how consistent this interpretation is with the current state of the law. 

Stuart Walsh and Clara Boyd are VAT dispute experts at Pinsent Masons, the law firm behind Out-Law.com