The exemption will allow insurers to pool their resources to secure VAT-efficient economies of scale. However, a corporate group can also take advantage of the exemption and establish its own CSE. This will be of particular interest in cross-border situations where it is often not possible to mitigate VAT costs through VAT grouping. The CSE can also join a VAT group.
It is worth noting, however, that the CSE can provide services to non-members at a profit. Here, the normal VAT rules apply and a profit motive is permissible.
The UK has “cut-and-pasted” the exact wording of the underlying European law into UK law and has released detailed guidance around how this should be interpreted. This guidance states that for the exemption to apply, the following tests (which have to be applied on a supply-by-supply basis) must be met:
- There must a separate person / entity which provides services to its members (being its shareholders or similar). HMRC has not been prescriptive over the legal form the entity can take; the taxpayer has broad discretion and could, for example, use a limited company, EEIG, partnership;
- All members must carry out at least 5% exempt or non-business activities;
- The CSE’s services must be “directly necessary” for the use by the members in their own exempt and/or non-business activity;
- The CSE must only recover an individual share of the expenses from its members; and
- The application of the exemption should not produce a distortion of competition.
Two of these tests merit further analysis:
EU Member States have implemented this test differently. The UK has taken the view that services are “directly necessary” if they relate exclusively to supplies and activities which do not carry the right to VAT recovery.
In addition, a member can treat all services from a CSE as exempt where its overall VAT recovery rate is 15% or less. This is good news for insurance companies, particularly general insurers, which typically have a very low VAT recovery rate. Furthermore, HMRC may also allow taxpayers to apply the exemption on a partial exemption sector or account code basis. This will likely benefit insurers with pockets of high recovery areas.
The requirement to recharge at cost would seem at first glance to preclude use of the exemption for intra-group supplies; any transfer pricing adjustment would necessarily deem there to be a profit. HMRC’s guidance has confirmed that the exemption can be used even where an adjustment is made; however, it is unclear at present whether the exemption is also applicable when an arm’s-length price is charged.
Therefore, any corporate group looking to benefit from the cost sharing exemption would need to consider the interaction with their transfer pricing strategy.
Clearly there are a number of opportunities to take advantage of the cost sharing exemption.
Insurers should consider their business models and the circumstances in which the CSE could be applied and work through the potential challenges and uncertainty around the interpretation of HMRC’s guidance. In implementing such a structure, it would also be important to consider the potential tensions between the cost sharing and transfer pricing requirements.
If you would like to discuss matters raised in this article, please contact Tessa Dost on 020 7311 5922, Richard Iferenta on 020 7311 2837 or your usual tax contact.