VAT rules are a mess in the EU financial services sector. The current regime dates from 1977, well before the development of the cross-border business we know today. The European Commission would like to bring these rules up to date and is currently in a consultation phase. We spoke to Vilma Domenicucci, ALFI’s senior tax advisor, about the changes the Luxembourg fund industry welcomes.
Although financial and insurance services firms have been exempt from charging VAT in the EU since 1977, they are not entitled to deduct input VAT paid on their purchases or supplies received, as is normal business practice. This is just one anomaly that the Commission is investigating. This aspect is of particular interest to Luxembourg’s fund sector which is often based on a host of outsourcing arrangements.
A review of VAT rules between 2007-2016 failed to reach a conclusion, but now the European Commission is making a new attempt at reform. A public consultation process was started last year and ALFI has just submitted its comments. It may be that the UK being absent from these discussions might change the dynamic.
“ALFI is in favour of maintaining the current VAT exemption for financial services,” said the association’s submission to the Commission, adding “ALFI is in favour of improving and harmonising the relevant definitions for the application of the exemption across the EU.” They couched their opinions with comments reminding the reader of how funds are central to retirement savings plans and are key for directing capital to the real economy. Changing tax rates would affect these mechanisms, they argue. They also called for greater flexibility in how VAT is applied to different products in different contexts.
Q: Why has the Commission requested this consultation now?
Vilma Domenicucci: After the official withdrawal of the previous EC consultation on the same subject in 2016, the context has evolved. In particular in 2017 the CJEU [Court of Justice of the EU] has rendered its judgements in relation to the independent group of persons, against Germany and Luxembourg respectively. Also, in the meantime the taxation of the digital economy has become an important topic that was tackled notably at OECD level with the idea to tax at the place where the customer is established and this was posing new challenges for VAT purposes.
Q: Do you think the motivation is generally to remove tax inefficiencies to help the financial sector thrive, or as a fund-raising measure for EU states?
Vilma Domenicucci: This review is larger and more ambitious than the previous one, aiming at an improvement and a harmonisation of VAT rules for financial services. The objectives of the European Commission as expressed in their roadmap in October 2020 is to tackle the lack of VAT neutrality and the legal uncertainty and regulatory complexity of the current system. A collection of any additional VAT amount would most probably be welcome for national authorities.
Q: What would be the main benefits for the Luxembourg fund industry of a “successful” reform?
Vilma Domenicucci: For investment funds, ALFI is in favour of maintaining the current VAT exemption for financial services with an improvement and harmonisation of the relevant definitions for the application of the exemption across the EU. The other important point is the review of the independent group of persons (or ‘cost sharing agreements’) and of the VAT group that are two complementary tools required for operators of all sectors, provided that both regimes would be available on a cross-border basis with clear, harmonised and flexible rules.
Alternatively, ALFI has looked into possible taxation of financial services with a reduced VAT rate. This option may help solve a number of issues, the zero-rate taxation being a good possible solution that would need to be further investigated, but this would be a major change. There is also the potential for the harmonisation of the relevant definitions and interpretations, which would be a significant move.
Q: What could be the main disadvantages of a botched reform?
Vilma Domenicucci: A botched reform would increase the cost of financial services on those who could not recover VAT, as is particularly the case for individuals such as retail investors and pension savers. It would also increase the risk of delocalisation of activities outside the EU which would be a possible option in consideration of the internalisation of the business and the use of new digital tools. Finally, reform might fail to achieve a sufficient level of harmonisation of VAT rules and their interpretations across the EU.