A recent ECJ ruling has far reaching implications for outsourced insurance services. Jeremy Hill and Vivienne de Chermont report
Tax is always something of a thorny issue for insurers. Across the EU, insurers generally pay VAT at standard rates on the expenses they incur in running their businesses with no ability to recover it by charging it at a similar rate on their insurance policies.
Outsourcing has offered insurers real benefit in tax terms, as services provided under them have often been treated as exempt from VAT under Article 13B(a) of the EC Sixth VAT Directive.
This rule provides VAT-exempt status not only for "insurance and reinsurance transactions" but also for "related services performed by insurance brokers and insurance agents".
This exemption had been widely viewed as applicable to the contracting out of all kinds of insurance-related services, enabling insurers to enjoy a valuable VAT saving.
But insurers in the UK and Europe are now facing a significant increase in irrecoverable VAT, following a recent European Court of Justice (ECJ) decision.
In Staatsecretaris van Financien v Arthur Andersen, the court decided that the services outsourced by Universal Life to Andersen's Accenture division were not within the scope of the Sixth VAT Directive's Article 13B(a) exemption.
The case is significant because Accenture had been providing Universal Life with "back office" administration services of a type used in outsourcing arrangements. These included processing insurance applications, accepting policy amendments, managing claims, paying intermediaries, providing management information and providing IT support.
Accenture was also authorised to accept insured risks meeting certain criteria on Universal Life's behalf and to set rates of commission payable to intermediaries. All activities were conducted in the name of and on behalf of Universal Life.
The ECJ decided that these services, looked at collectively, were not indicative of an "insurance broker or agent" role within the scope of the exemption. In reaching this decision, the ECJ interpreted that role in a very narrow way.
The court took the view that the key characteristics of an insurance broker or agent were:
And all of these features were absent from the Accenture contract.
The court also decided that some aspects of the services - determining and paying commission - were decidedly not part of an insurance broker/agent role.
This is a much more restrictive interpretation of an insurance broker or agent than that applied under the Insurance Intermediaries Directive.
The Insurance Intermediaries Directive includes assisting in the administration and performance of an insurance contract within its definition of an insurance intermediary, as well as introducing insureds to an insurer or concluding insurance contracts.
What the ECJ effectively did was to limit the application of the exemption to a person performing a typical broker role.
The services provided by Accenture to Universal Life, in contrast, effectively enabled it to run a 'virtual' insurance operation. The ECJ held that providing services of a type which would otherwise have been carried out by an insurer for itself was outside the scope of the exemption.
The potential effect of this decision on the UK's insurance outsourcing market should not be underestimated, particularly in the run-off sector.
New business is no longer being acquired and it is common under these outsourcing arrangements for the provider to carry out most, if not all, of the insurer's role, often in the insurer's name.
Run-off administration contracts therefore lack all of the key characteristics, which the ECJ thought was necessary to bring an arrangement within the scope of VAT exemption.
The duration of a typical insurance outsourcing arrangement also makes the ECJ decision problematic.
Insurance outsourcing contracts are generally long term arrangements, often with a fixed term of 10 years or longer, generating substantial revenues over the course of the contract (in excess of £300m in some cases).
Imposing an additional charge of 17.5% on the value of services provided under contracts of this kind has to call into question their economic viability, especially in the run-off market, where pressure on expenses is greatest and may make alternatives, such as an outright sale of a closed book, more attractive.
The immediate impact of the case is to require the UK, like other EU countries, to make whatever changes may be required to domestic legislation to ensure that it is consistent with the ECJ's decision.
HM Revenue & Customs has recently issued a Business Brief, in which it confirmed that the VAT provisions were too widely drawn, in the light of the Accenture case and will need to be amended.
Following the series of meetings currently taking place between customs and insurance industry representatives, there will be a
12-week consultation period on how and when those amendments will be implemented.
Customs has said that no action will be taken to change UK law or policy before consultation is complete. It is difficult to assess exactly how customs will translate the ECJ's decision into UK law. But customs has already indicated that, in its view:
A thorny issue has become much thornier. IT
' Jeremy Hill is a partner in, and Vivienne de Chermont is international counsel with, Debevoise & Plimpton