Weathering Europe's VAT storm

' Last week the European Court of Justice's (ECJ) gave a landmark ruling on the tax status of outsourced insurance services.

The decision has sent shockwaves through the insurance industry as fear mounts of a multi-million pound hike in companies' VAT bills.

Lawyers are already gearing up to challenge the ruling and industry groups are preparing to lobby the UK government to soften the blow.

In its decision the ECJ said that insurance companies will no longer be exempt from paying VAT on outsourced services, including back-office functions like checking insurance applications, IT support, claims management and manning call-centres.

For the big insurance companies the fall-out could be massive. Experts say that VAT on the UK insurance industry's biggest outsourcing contracts could add up to more than £100m.

Brokers on the other hand appear to have been handed a reprieve.

The court turned its back on an initial judgment released by the advocate general last month (News, 3 March) which if followed would have left brokers and agents also facing huge tax hikes.

ECJ advocate general M. Poiares Maduro had argued only those intermediaries who could prove they had a direct link between both insurer and insured would continue to be VAT exempt, leaving wholesale brokers and broker chains exposed to additional tax.

But the ECJ shied away from the advocate general's initial judgment, which emphasised the need for a direct relationship between the insurer and the insured. Instead it mounted a direct attack on outsourced activities.

Peter Mason, a tax expert at CMS Cameron & McKenna, says: "Providing a broker's work is ultimately leading to agreement between insurer and insured, then he will continue to be exempt from paying VAT.

"It doesn't matter if he passes business to another broker, and that broker passes it on to another broker - as long as the ultimate goal is to facilitate a contract between the customer and the insurance provider he will be safe, regardless of the length of the chain."

Grant Ellis, chief executive of The Broker Network, sums up the broking fraternity's response when he says: "I'm delighted that common sense seems to have prevailed."

But the precise implications for UK insurers and brokers are still uncertain. It is for Customs and Excise to interpret the ECJ's ruling, with final guidelines expected by the end of the summer.

KPMG senior tax adviser Frank Sangster says UK Customs' interpretation will not be easy to predict. "Only after Customs lays its hand will we really know the extent of the damage," he says.

So brokers may still not be off the hook if the UK takes a very broad definition of outsourcing.

A useful marker for predicting Customs and Excise's stance is to look at the way it has treated sections of the industry in the past, says Sangster. "Outsourced call-centre operations, for example, have been subject to customs scrutiny in the past. This ruling would appear to open the door for removing their tax exemption."

So could the decision mean the end of outsourcing? Sangster thinks not: "I advised a client this week on the ramifications of paying VAT on its outsourcing activities, which constitute between 60% and 70% of its total business model.

"My advice was that it is still far more cost effective to outsource." In other words, the added cost of VAT is unlikely to lead to major structural changes for the big insurers, even if it is a bitter pill to swallow.

In the coming months there will be intense lobbying. The ABI is meeting UK Customs this week and tax lawyers have also been pencilled in for meetings.

A lot will rest on the ABI's powers of persuasion to put the industry's case across in what may best be described as a damage limitation exercise. IT