VAT and outsourcing in the financial services sector

VAT is potentially a significant cost of outsourcing for businesses in the financial services sector. Several methods are used to eliminate or reduce this VAT cost. This article highlights some recent and prospective changes to VAT law and its interpretation, which affect outsourcing transactions.

VAT is not incurred on salaries paid to employees or on services provided by one company to another within the same VAT group registration. However, VAT is payable on most services provided by a third party. Consequently, when a business outsources activities to a third party this will generally give rise to a VAT charge that was not previously payable. Most businesses in the financial services sector are unable to recover from HM Revenue & Customs (HMRC) much, if any, of this VAT. In view of this, if VAT is chargeable on outsourced services it will generally represent a cost of the outsourcing to a financial services business.

Jurisdictions are increasingly turning to VAT and similar consumption taxes, rather than taxes on profits or income, to raise revenue and make up budget deficits. The UK increased its standard rate of VAT from 17.5% to 20% with effect from 4 January 2011 and numerous other jurisdictions have recently increased VAT rates or introduced VAT. In view of this, the potential VAT cost of outsourcing is increasing and it is as important as ever to seek to mitigate this where possible.

The methods used to reduce the VAT cost of outsourcing can be divided into the following three broad categories:

  • structuring the arrangements so that they do not give rise to a supply for VAT purposes;
  • ensuring that the services are treated as provided in a jurisdiction where VAT is not payable; and
  • structuring the services so that they are wholly or partly exempt from VAT.

Each of these are discussed below.


VAT is payable on transactions that are treated as supplies of goods or services for VAT purposes. Therefore, VAT costs can be avoided if an outsourcing arrangement does not give rise to any supplies by the service provider to its customer for VAT purposes.

The challenge with this approach to VAT mitigation is to implement and document the arrangements so that they have the legal form required to achieve the desired VAT treatment while preserving the desired commercial objectives and terms of the outsourcing.

Historically, one way of avoiding a supply being made was to take advantage of the UK VAT grouping rules to include the service provider in the same VAT group registration as its customer. As mentioned above, no UK VAT is generally payable when one company provides services to another company that is a member of the same VAT group registration. In 2004 anti-VAT avoidance provisions were introduced with a view to preventing such use of VAT grouping on outsourcings. Notwithstanding this, there remain several instances in which it is possible to make use of VAT grouping, partnerships or joint venture structures to reduce VAT costs on outsourcing transactions.

Another method that has been used to structure outsourcing arrangements, so that no supply is made by the service provider to the customer, is to make use of joint employment contracts. This relies on the fact that VAT is not chargeable in relation to salary and certain other employment-related costs paid by an employer. In addition, HMRC accepts that where a person is jointly employed and one of the employers meets all salary, National Insurance Contributions and pension contributions, and then recharges a portion of these amounts to the other employer, such recharging of costs is not subject to VAT. In light of this, in some instances, outsourcing arrangements have been structured so that people undertaking the outsourced activities are jointly employed by both the service provider and customer, with a view to structuring part of the fee for providing the outsourced service because a recharge of employment costs does not attract VAT.

An IT outsourcing arrangement of this nature has recently been successfully challenged by HMRC. In CGI Group (Europe) Ltd v Revenue and Customs (Rev 1) [2010], the First-tier Tribunal held that VAT was chargeable by the service provider in respect of all amounts paid by a customer, notwithstanding the fact that the individuals undertaking the services were jointly employed by the customer, and part of the payment to the service provider was intended as a recharge of salary and other employment costs. The employees were transferred from the customer, an insurance group, to the service provider under the Transfer of Undertakings (Protection of Employment Regulations) and then became jointly employed by the customer and service provider. The service provider had contended that the payments received from the customer represented the recharge of salary and other employment costs.

The Tribunal held that, based on the documents and facts, although the employees were jointly employed by the service provider and customer, when the employees were providing the IT services to the customer they were doing so solely under the control and direction of the service provider. Consequently, the payment was for the provision of services by the service provider via the individuals in their capacity as employees of the service provider. The payment was not a recharge of salary and other employment costs in respect of the individuals in their capacity as employees of the customer.

Notwithstanding this judgment, there remain opportunities to make use of joint arrangements in relation to employees to mitigate VAT on outsourcing. The Tribunal accepted, for example, that the VAT treatment of the arrangement would have been different if the service provider had been contracted to manage the employees on behalf of the customer. In such a case, VAT would be chargeable on the fee charged for managing the employees but payments by the customer to meet the employees’ salaries and other employment costs would not be subject to VAT.


Until the start of 2010, a common structure used to reduce the VAT cost of outsourcing transactions was to take advantage of the rules for determining the place where services are treated as supplied for VAT purposes. In particular, where some or all of the outsourced services could be structured so that they could be characterised as general administration or management services, it was possible to treat such services as provided where the service provider was located, rather than the customer. The place where the services are treated as provided dictates which jurisdiction has the right to impose VAT on services. Consequently, if the service provider supplied the services from a jurisdiction that does not impose VAT on the services, this enabled VAT to be avoided.

The VAT rules for determining the place of supply of services to business customers were changed across the EU with effect from 1 January 2010 as part of the ‘EU VAT package’. From that date, administration and management services provided to a business customer are generally treated as supplied where the customer is located and that jurisdiction has the right to impose VAT on such services. This has greatly reduced the scope for a UK business (or a business in any other EU member state) avoiding VAT being payable on outsourced services by structuring the services so that they are provided from a jurisdiction that does not impose VAT on the services.


Another method of seeking to minimise the VAT costs of an outsourcing is to seek to structure the services so that all or some of them fall within an exemption from VAT.

It is an established principle of VAT law that the exemptions should be construed narrowly. Therefore, where outsourced services do not fall squarely within the scope of a VAT exemption there is a risk of HMRC seeking to challenge the VAT exempt status of the services.

Often, outsourced services include certain elements that fall within an exemption from VAT and other elements that do not. In such cases, there is scope for seeking to structure the provision of the various elements in the most tax-efficient manner. Where, for instance, a significant element of the outsourced services is exempt from VAT, but certain elements would be subject to VAT if provided separately, it will generally be beneficial to seek to ensure that the elements are bundled together so that they are treated as a single composite supply for VAT purposes that is wholly exempt.

Where the elements of the service that would be subject to VAT if provided separately cannot be said to be incidental or ancillary to the exempt elements, then it will generally be advisable to ‘unbundle’ the exempt elements, for example, by having them provided under a separate contract and, ideally, by a separate entity to that providing the elements that are subject to VAT. Otherwise, the exempt elements may be treated as forming part of a single composite supply of services that is wholly subject to VAT.

There have been several cases before the UK courts and the European Court of Justice (ECJ) that consider the scope of VAT exemptions in the outsourcing context. The latest of these is HMRC v AXA UK plc [2010], in which the ECJ held that the operation of a payment plan between dentists and their customers did not qualify as a VAT-exempt service of transferring money. The services provided to dentists by Denplan Ltd, a member of the AXA VAT group, consisted of requesting a patient’s bank to transfer payment to Denplan’s account by direct debit, transferring the payments received, less a fee, to the dentist’s bank account, giving the dentist details of what payments have been received and what payments have not, and contacting patients from whom payment has not been received. The ECJ held that Denplan was providing a single composite supply of debt collection services, ie requesting the transfer of the sums due to the dentists, via the direct debit system. As debt collection services are expressly carved out of the VAT exemption for payment transfers, VAT was chargeable in respect of such services. The court also held that it is irrelevant to the treatment of the service as debt collection whether the debts have become due at the time the service is provided and that there is no provision for coercive measures for the effective payment of the debts.

Several outsourcing transactions have been structured with a view to taking advantage of the exemption for money transfers. In view of the decision in AXA, the VAT exemption for money transfers is far narrower than had previously been considered and, consequently, in many instances VAT will be chargeable in respect of such outsourced services. HMRC interpret the decision as meaning that all services principally concerned with collecting payments from the person owing them for the benefit of the person to which those amounts are payable are subject to VAT. Where a business has previously relied on a ruling from HMRC or its published policy to treat services of this nature as exempt, then VAT should be charged on such services from 12 January 2011 onwards.

In late 2007 the European Commission proposed amendments to the EU legislation relating to the VAT exemptions for financial and insurance services. The proposed changes include seeking to clarify the scope of some of the exemptions and will be relevant to outsourcing transactions. It was intended that these changes would be implemented at the start of 2010. The prospective changes have been delayed, however, due to disagreement between member states in respect of certain of the proposals. Consequently, it is currently uncertain when the proposed changes will be made and the precise form that they will take. However, it is important to keep abreast of the progress of these proposals as they are likely to affect outsourcing transactions.


It can be seen from the above that complex VAT issues can arise on outsourcings by businesses in the financial services sector. Where outsourcing arrangements are being structured, with a view to mitigating VAT, it will be important to ensure that the documents clearly reflect and implement the intended structure. In addition, as there will often be a fair degree of risk that the VAT treatment of the arrangements may be challenged by HMRC, or affected by a change of law or its interpretation, it will be important for each party to ensure that the documents allocate such risk and the associated costs appropriately.

By Clive Jones, partner, Eversheds LLP. E-mail: