By Kamlesh Chauhan, Senior Manager VAT, haysmacintyre – After another tumultuous week of politics, the Commons’ vote on the draft Brexit deal has been delayed. Uncertainty therefore remains over the VAT treatment of intra-EU supplies of services once the transition period begins on 29 March 2019. Whilst politicians have so far failed to agree on the draft withdrawal agreement, now is a useful time to consider the proposals for VAT and how this could affect hedge funds, particularly as a ‘no deal’ Brexit could bring good news for some businesses.
The transition period will last 21 months from March 2019, during which time the UK would continue to follow EU rules and crucially, from a VAT perspective, it would remain under the jurisdiction of the Court of Justice of the European Union (“CJEU” or “ECJ”). The current draft agreement states that the Principal EU VAT Directive (Council Directive 2006/112/EC) will continue to apply to supplies of goods between the UK and the EU in the transition period (and for five years following in respect of goods already supplied in the transition period).
However, the draft agreement does not discuss how financial services, in particular the sale of financial instruments, would be treated for VAT purposes when made within the EU. Assuming that the same principles may apply as for other services, it may be that the intention is that the current VAT rules will continue to apply. Although, this doesn’t really help financial services businesses including hedge funds, it should at least provide some certainty to VAT matters and ensure that businesses can continue to rely on the current rules and on case law handed down by the CJEU in the past for VAT matters.
Recent events suggest that we are now facing the real possibility of a “no deal” Brexit and transition period and this makes things more challenging and interesting when considering the implications for VAT.
HMRC recently published guidance on what happens to VAT for businesses if there is no deal, and there is a potential silver lining for many financial services businesses that currently receive income from the EU and currently have irrecoverable VAT costs.
In most cases, the government expects to align closely to the existing rules for trade with other EU member states, however, in respect of financial services there may be a notable exception.
The HMRC guidance currently states that: “For UK businesses supplying insurance and financial services, if the UK leaves the EU without an agreement, input VAT deduction rules for financial services supplied to the EU may be changed. We will update businesses with more information in due course.”
In order to understand the impact of any potential changes, it is important to explain how the current rules work. Supplies of financial services including any intermediary services are given special credit for VAT recovery when they are provided to recipients outside the EU. This includes the sale of any financial instruments (including equities and credit) to non-EU purchasers.
This acts as a special incentive to try to encourage financial services to be exported outside of the EU and for the increase of capital investment into the UK/EU.
VAT incurred on business costs used to generate these supplies that are “exported” can be reclaimed in full, which is in stark contrast to what happens when the same services are supplied to UK or EU clients, where no VAT recovery can be applied to related costs.
For many observers, following a “no deal” Brexit, it would make sense for the UK to apply the same logic in order to try and encourage the export of financial services from the UK to anywhere outside of the UK. Should this be adopted, this would essentially mean that any sale of financial services to any business outside the UK would allow for the VAT recovery of the related costs used to generate those services. This would be a welcome boost for any UK hedge funds who currently do not achieve a full VAT recovery of their costs due to having exempt financial transactions with other EU member states.
However, if the UK adopted such a stance, there are two main drawbacks. Firstly, this would result in a significant loss of revenue for the Treasury, and secondly it may be politically difficult to manage providing only the financial services sector with such a VAT boost. Ultimately, as a result it may be that HMRC intends to maintain the current status quo and will not allow for such additional VAT recovery. We hope that the New Year will bring some clarity to the situation.
