Member states restrict deduction of input VAT in financial and insurance transactions
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The core principles of the EU VAT system prevent financial service providers from deducting input VAT on goods and services they acquire to supply exempt financial services to a customer residing in another or the same member state (e.g. a bank and its customer are both in Latvia). Supplying exempt financial services to non-EU persons is an exception.
Taking advantage of this exception, some financial and insurance service providers are setting up structures and planning their operations to involve non-EU entities in acquiring and supplying exempt services. A typical structure uses a non-EU jurisdiction without a VAT system to avoid creating an extra burden there. To secure a favourable VAT treatment the service provider’s costs incurred in performing such activities are accumulated in that non-EU jurisdiction, and supplies of exempt services to customers resident in the service provider’s member state are made through non-EU entities. This gives them input VAT deduction rights that would otherwise not exist.
Considering the widespread use of such practices and having estimated the harm they have done to domestic revenues, countries such as the UK are proposing amendments to their national VAT legislation to fight artificially created structures.
The proposals appear to be mainly caused by the lengthy and unsuccessful litigation in the Hastings Insurance case, which created the need for a drastic decision. Although relevant to the circumstances of the case, the court ruling is unfavourable to the tax authorities and might give the green light to other multinational enterprises that are using a network of subsidiaries and cross-border chains of service supplies.
The proposals provide for adopting the so-called see-through principle in deducting input VAT on financial and insurance services to restrict deductions on services supplied to non-EU persons if their actual end consumer is located in the UK.
Some Latvian companies, too, have set up structures with non-EU entities, and so we would recommend re-evaluating those structures to ensure they have a valid business purpose to avoid tax risks in the future.