Specified supplies transitional guidance

HMRC has published guidance on how businesses should treat input VAT incurred in relation to specified supplies of finance and insurance to EU customers, which span the end of the Brexit transition period. As well as covering input VAT on supplies which span the end of the transition period, the guidance also deals with the impact on partial exemption special methods, particularly where provisional figures have been used based on the (less generous) pre-end of transition position.

Background

Under the VAT rules in place before the end of the transition period, a business providing certain specified supplies of services (such as insurance and financial services) to a person outside the EU was entitled to input VAT recovery on the costs associated with those supplies. Such "specified supplies" attract beneficial input VAT treatment pursuant to the VAT (Input Tax) (Specified Supplies) Order 1999 (the Specified Services Order).

One of the main consequence of Brexit is that the EU (from a UK perspective) essentially has become a "third country" and accordingly the rules for the place of supply of services will generally apply as if supplies of services to an EU customer are to a third country customer. Although there was initially some doubt if the Specified Supplies Order would be extended to exempt supplies of insurance and other financial services to EU customers, the government confirmed in late 2020 that the ability to recover input VAT on costs associated with supplies of financial services and insurance would be extended to the situation where such supplies are exported to EU customers. This change was then effected by the VAT (Miscellaneous Amendments, Northern Ireland Protocol and Savings and Transitional Provisions) (EU Exit) Regulations 2020 (SI 2020/1545) with effect from 11pm on 31 December 2020.  

Supplies of financial services (including insurance) are normally exempt from VAT meaning that the supplier of such services is unable to recover any associated input VAT that it incurs. The Specified Supplies Order provides an important exception to this rule in the case of financial services which are "exported". The decision to extend the ability to recover input VAT on costs associated with supplies of financial services and insurance to the situation where such supplies are exported to EU customers has been greatly welcomed therefore.

These specified supply rules also apply to supplies of services in connection with an export of goods to persons belonging in the EU.

Transitional guidance

HMRC has now published additional transitional guidance on how businesses making such supplies which span the end of the Brexit transition period should deal with them for VAT purposes.

Directly attributable input tax incurred before 11pm on 31 December 2020 that is used exclusively to make an exempt financial supply to a person belonging in the EU before 11pm on 31 December 2020, is directly attributable to an exempt supply and, in principle, carries no right to recovery.

However, where a business is partially exempt and using the standard method or a HMRC approved special method which provides for an annual adjustment, then the input tax claimed in each tax period is provisional and is reviewed in the longer period adjustment. This may enable re-attribution of input VAT where the annual adjustment period ends after 11pm on 31 December 2020. (Where the longer adjustment period ends before 11pm on 31 December 2020, then HMRC confirm that input VAT directly attributed to an exempt financial supply to the EU cannot be re-attributed to a future taxable specified supply or residual. This is because at the end of the tax year to which the longer period adjustment relates, financial supplies to the EU carried no right to deduct.)

Re-attribution to a taxable supply

HMRC confirm that for partial exemption purposes financial services that fall within the Specified Supplies Order are treated as taxable supplies and that input tax originally attributed to an exempt financial supply to the EU can be re-attributed to a taxable supply as part of the longer period adjustment provided all of the following conditions are met:

• the input tax has not been used to make an exempt supply prior to 11pm on 31 December 2020;
• the supply which it will be used to make is a specified supply made after 11pm on 31 December 2020; and
• the longer period adjustment relates to a tax year ending after 11pm on 31 December 2020.

Re-attribution to residual

Input tax originally directly attributed to an exempt financial supply to the EU can be re-attributed to residual as part of the longer period adjustment relating to a tax year ending after 11pm on 31 December 2020 provided one of the following conditions are met.

The input tax:

• has not been used to make exempt supplies prior to 11pm on 31 December 2020 and is used, or intended to be used, to make both exempt and specified supplies after 11pm on 31 December 2020; or
• is used in part to make exempt supplies prior to 11pm on 31 December 2020 and also used or intended to be used in part to make specified supplies or both exempt and specified supplies after 11pm on 31 December 2020.

Input tax incurred after 11pm on 31 December 2020 that is used exclusively to make a specified supply to a customer belonging in the EU after 11pm on 31 December 2020, is directly attributable to a taxable supply and carries a right to recovery. However, where a business incurs input tax after 11pm on 31 December 2020 that is a cost component of an exempt financial supply to a customer in the EU made prior to 11pm on 31 December 2020, the input tax is directly attributable to an exempt supply and carries no right to recovery. HMRC provide the example of an insurer incurring input tax on legal fees for an insurance claim after 11pm on 31 December 2020 that relates to a supply of insurance made before 11pm on 31 December 2020.

Partial exemption methods

In relation to the calculation of residual input tax under a partial exemption special method (PESM), VAT Regulations 1995 reg 102(2A) has been amended so that the wording of any previously approved PESM will be interpreted in accordance with the revised Specified Supplies Order. This change has been made to ensure that businesses will not need to apply for a new PESM, as the new treatment to allow VAT recovery on costs associated with specified supplies to the EU will automatically be read into existing PESMs.

An amendment has also been made to the partial exemption use-based calculation in regulation 103B(3)(a) so that the use-based calculation will allow for recovery on incidental specified supplies to the EU.

Some businesses may have an approved PESM which requires them to deduct input tax provisionally in each VAT period using the previous year's recovery rate which is then finalised using the actual year's figures by way of the longer period adjustment. This is normally used as a form of simplification, but may now operate to the detriment of a business in the short term. In these circumstances, HMRC state that a business which wishes to amend their PESM so that they no longer use a provisional recovery rate or wish to use the previous year's recovery rate which takes into account the changes made to the Specified Supplies Order, this would require a change to their PESM and a new PESM would need to be approved by HMRC. However, HMRC also indicate that where this results in a business provisionally having a lower recovery rate but the longer period adjustment will correct this position so that there is no loss of input tax, HMRC would consider the PESM to be fair and reasonable and a new PESM would not be appropriate.

In the case of a business on the standard method that uses the previous year's recovery rate to determine their recoverable residual input tax in each tax period, HMRC state that they may, at the beginning of their next tax year, choose to calculate their recoverable input tax by calculating separate recovery percentages for each VAT period so long as they apply this method consistently for the whole tax year.

Tax point for insurance premiums

Finally, the guidance recognises that insurers may have difficulties identifying the premium received date for tax point purposes. Accordingly, HMRC indicate that insurers may use their current VAT accounting approach to determine their tax point in relation to insurance premiums on the basis that this is:

• consistent with their accounting basis; and
• aligned with the expenses incurred on which VAT is being recovered in the relevant period.

Comment

This guidance has been expected for a while and some businesses which have already undertaken their annual adjustment in respect of financial years ending in January or February may need to consider whether they need to revisit their calculations. HMRC's comment that businesses on the standard method may, at the beginning of their next tax year, choose to calculate separate recovery percentages for each period may be viewed as unhelpful by some businesses when issued this length of time after the end of the transition period.

Businesses should review their position as soon as possible in order to understand whether they could benefit from a revised partial exemption special method. Businesses should also critically assess any input tax incurred prior to 31 December 2020 to understand whether it was wholly used for exempt supplies prior to 31 December 2020 or whether it is in fact used on a mix of exempt and taxable supplies or wholly taxable supplies.

Finally, companies may wish to asses whether they need to evaluate their existing business structure and contractual flows in light of the revised treatment for supplies made to EU entities.