Under threat from the VAT man.

The UK insurance industry could be hit with an annual value-added tax (VAT) bill of up to £1bn if it...

The UK insurance industry could be hit with an annual value-added tax
(VAT) bill of up to £1bn if it fails to mount a successful challenge to
government proposals tabled in June this year.

If the new proposals, published by HM Customs & Excise (C&E) in a document
entitled 'Restriction of VAT Groups to Fully Taxable Corporate Bodies',
become law they will effectively remove a 25-year-old rule allowing
transactions between companies that are technically related to each other
to be disregarded for VAT purposes.

Insurers have traditionally arranged themselves into groups of companies
so that they do not artificially create a VAT bill on staff and other
costs that are used for common purposes. The subsidiaries that provide
these services would normally have to charge VAT, but under the current
rules they do not because, where the same shareholders control the
companies, they are able to form a VAT group operating under a single VAT
registration number.

The exclusion from VAT makes sense because the services provided by the
subsidiaries are of the type, such as staff and IT costs, that would be
handled in-house in a smaller company. Insurers often comprise 20-30
subsidiary companies that form commercially defined units.


The C&E proposal will force the UK's insurance industry to reorganise
itself along uncommercial lines, which could put it at a competitive
disadvantage in the global market.

The companies will face the dilemma of paying more in VAT or biting the
bullet and restructuring themselves, which could, in turn, have serious
corporation tax consequences. Restructuring is not easy, involving as it
does a great deal of money in management time and commercial

Whatever the insurance industry decides to do, the move could not have
come at a more inopportune time. Rival centres such as Dublin and
Luxembourg have been successful in enticing large captive companies and
general insurers into their financial districts by offering an
irresistible cocktail of low corporation tax rates and zero VAT on
financial services. London-based companies have been able to compete
because, as well as having a mature commercial infrastructure, tax rates
in this country have dropped in recent years. If these new proposals
become law, companies could begin to drift from London in search of better
trading conditions elsewhere.


Other European tax officials will perhaps follow the move by the UK
authorities at a later date. It is well known that the European Commission
is currently reviewing the whole area of VAT grouping in light of the
introduction of the single currency by 11 countries on 1 January 1999.

The commission itself has identified three options:

- an EC-wide abolition of the grouping facility;

- the extension of the grouping facility to all member states, along with
harmonising regulations; and,

- maintenance of the status quo, involving a degree of harmonisation for
those countries with grouping facilities.

While the discussions are still taking place, the initial signs are that
the commission wants to leave well alone.

In fact, the whole exercise is unnecessary. Those reading the background
notes to the paper will soon realise that C&E already has wide-ranging
anti-avoidance measures when it comes to preventing revenue loss through
bending the group rules.

C&E can at any time refuse a group of companies permission to be treated
as a group for VAT purposes, if it is considered necessary to do so for
the protection of revenue. This removes the opportunity for tax

However, its powers do not stop there. If VAT officials feel that an
existing VAT group is deliberately milking the system, they can break the
whole group up or dictate which companies are allowed to be a part of the
VAT group and which are not.

After 25 years of operating this system successfully, C&E now believes it
needs further powers. Those who doubt just how determined C&E is to get
these powers should read the document.


At the end of the paper's introduction to the issue, C&E says that a
number of options have emerged for consideration. These rightly range from
the complete abolition of the group system in VAT to proposals that would
do no more than tinker at the edges.

In between, the options include restricting the facility to fully taxable
companies, increasing C&E's powers so that it can direct the composition
of groups more completely and altering the rules so that grouping operates
only at the discretion of C&E officials.

However, the business community is not invited to comment on any of these
issues. Instead, C&E seems to have already made up its mind that VAT
grouping will be abolished for partially exempt businesses - a measure
designed to hit the insurance and financial sectors. Under the proposals,
companies will not be able to form, join or remain in a VAT group if they
are partially exempt for VAT purposes, above a prescribed de minimis

Comment is invited only on the finer points of how this should be

Even these are couched in terms that limit the kind of response that can
be submitted. Businesses are invited to comment on:

- what the de minimis limit should be;

- how concessions to allow one-off supplies of such services to be
eligible for group relief could operate; and,

- any "additional costs, including compliance costs, (which) would arise
of necessity, as the result of such a change".

For the insurance industry, these issues are an irrelevance. A de minimis
limit, by its very nature, will be meaningless because it is bound to be
set at such a low level that it would apply to all but a few insurance
businesses. Similarly, what company is likely to provide a one-off supply
of insurance services?

Most tellingly, C&E is not planning to compensate companies for the cost
of any restructuring undertaken because of the measures. It is, in effect,
ignoring the commercial realities of why these groups exist at all. In
addition, any suggested amendments to the proposals still need to meet
C&E's "revenue and administrative concerns".

The proposals are little short of a diktat and should be vigorously

If we are to have consultation on a change to the VAT grouping rules, let
it be on all of the options available. Insurers should be particularly
active when it comes to mounting a challenge to the proposals. They are
the biggest single group to be affected by the changes and will shoulder
most of the estimated £1bn tax bill each year after the rules become

The rules discriminate against insurers because they only abolish VAT
groups for partially exempt businesses, of which insurers form the largest
part. If VAT groups are a tax avoidance ploy, why not abolish them for all
business sectors?

Insurers are going to have to campaign hard to convince the government
that they have a good case. C&E says in the document that the cost of
abolishing grouping will be as low as £400m. This is a lot, but it is wide
of the mark.


In the 1995-96 fiscal year, the Treasury identified a £6bn shortfall in
VAT receipts. Yet the subsequent Treasury report into the matter found
that there was no quantitative evidence of avoidance, either among the top
20 VAT-payers - accounting for 15% of all VAT paid - or by packaging
products to benefit from zero rating.

It found only anecdotal evidence of increasing tax avoidance, though this
would include activity by firms faced with ever-increasing penalties
seeking to improve their tax planning and minimise their VAT

The main cause of the shortfall was found to be inaccurate forecasting,
although the Treasury would deny this and C&E insists in the consultation
document that the new measures are aimed solely at preventing tax

As much as £2bn of the overestimate in 1995-96 stemmed from changes to the
Bad Debt Relief system and rises in the VAT threshold for businesses.

A further £400m related to fees for court cases where C&E had incorrectly
interpreted the law and lost the case. The last time VAT receipts actually
exceeded the forecast was 1988-89. With this in mind, Neville Russell
estimates that the true cost of the new proposals to the insurance and
finance sectors will be much nearer to £1bn than to the £400m estimated by


The government has put the proposals out to consultation until 30

Now is the only time that insurers have to put their views forward on the

They should do so, as the government has listened to the views of
individual industry sectors in the past and has allowed these to influence

This happened in the financial services sector over proposals on
Individual Savings Accounts (ISAs).

Neville Russell is organising a unified response to the proposals. You can
join the campaign by contacting VAT consultant Robert Jones at Neville
Russell, 24 Bevis Marks, London EC3A 7NR.
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