European insurers outsourcing work face VAT hurdle

European insurance companies outsourcing their back-office operations could face a huge tax liability on removal of exemption of value-added tax (VAT).

This will negatively impact the insurance business outsourced to India and the rest of the world. Insurance companies in the European Union (EU) are exempted from paying VAT, as governed by article 13(B)(a) of the Sixth EU Directive.

On January 12, 2005, the advocate general of the European Court of Justice delivered his opinion regarding the Andersen Case (Arthur Andersen), which concerns the VAT status of back office activities provided to Universal Life, an insurance company in the Netherlands.

The advocate general stated that the activities are neither out of scope of VAT, nor qualify as VAT exempted insurance transactions.

"The removal of the exemption would be a major threat, and could become applicable for UK insurance companies since the Netherlands has taken the lead. A VAT of 17.5 per cent in UK, would result in our losing the margin differential," said R K Ragan, managing director, Prudential Process Management Services (PPMS).

The UK has currently given a fairly wide scope to the VAT exemption to insurance related services, thereby encouraging the trend for UK insurers to outsource such services.

In addition to Prudential Plc, players like Aviva have outsourced operations to India. Standard Life Plc is equally looking at the option today.

Should the European Court of Justice remove the exemption given to insurance companies today, the sector will be forced to reconsider their outsourcing business models.

This is as an additional VAT cost could ruin the business case for outsourcing.

To remove the distortions caused by exemptions in the field of tax, the European Commission is considering to introduce VAT for financial and insurance services.

The services provided to the insurance company included acceptance of requests for insurance, handling of requests for amendments to the insurance policies, handling of claims, termination of insurance policies, calculation and payment of commissions to insurance agents, design and management of IT systems.

The UK-based Prudential Plc is saving 16 million pounds annually following its outsourcing or as its group chief executive, Jonathan Bloomer, said: "it is more an offshore centre for our UK operations".

According to an international news site, if the exemption is withdrawn, insurance companies will immediately be concerned about their current outsourcing contracts.

A typical outsourcing contract can be anything from œ 500,000 to œ 100 million per annum and therefore the additional VAT, which would not have been budgeted for, could reach up to nearly œ 20 million per annum, stated the website.

When you consider that such contracts are commonly entered into on a long term-basis often for as much as 10 years, this is clearly a significant issue.