UK: Outsourcing: Additional VAT Burden For Insurance Companies

The Dutch Supreme Court requested a preliminary ruling from the ECJ on whether the back office functions that Accenture (formerly Arthur Andersen Management Consultants) carried out for the insurer Universal Life were VAT exempt for the purposes of Article 13B(a) EC Sixth Directive. The services provided by Accenture included acceptance and checking of applications for insurance, handling insurance policy changes, claims management, calculation of payment of commissions to agents, provision of policy-related information to insurers and agents, drafting reports to policy holders and third parties, and dealing with termination and variation of policies.

Previously it was considered that many of the services fell within the VAT exemption for "insurance related services provided by insurance brokers and agents" (see VATA 1994, Sch 9, Group 2, item 1, which implements Article 13B(a) EC Sixth Directive in the UK). However, the ECJ found that the relevant services did not fall within the exemption as the service provider did not have the necessary contractual relationship with the insured parties and the activities did not constitute the services that typify those of an insurance agent, particularly as they lacked the essential intermediary aspects normally associated with the work of an insurance agent.

The ECJ ruling makes it clear that when back office functions are outsourced by insurance companies, the service provider must charge the insurance company 17.5% VAT in respect of its service fees. As insurance companies provide VAT exempt services, they are unable to recover the VAT input costs that they incur in providing their insurance services. The practical effect of the decision is that:

• Insurance companies which have outsourced their back office functions will now be faced with the increased cost of an additional 17.5% of irrevocable VAT.
• Insurance companies which were thinking about outsourcing their back office functions will have to assess whether the proposed outsourcing would still be a viable commercial proposition, taking into account this new additional cost.

Representatives of the insurance industry have already held meetings with Customs to discuss how Customs will respond to the decision and deal with existing and new outsourcing contracts. We understand that Customs will respond by publishing a "business brief ". It is expected that there will be a consultation process thereafter between Customs and the insurance industry.