Digitalization is a trend that will – and already has – changed the way how financial services are being provided: for instance, physical bank offices have been reduced to client-face façades while the great majority of the value of financial services is being produced digitally via e-banking and other e-solutions.

On the first hand this seems like a huge opportunity for banks and other FS companies to rationalize their business: they don’t have to pay for office walls anymore but they can utilize new service models like SaaS or cloud-based solutions and to outsource the production of certain service process in full or partly to external providers to gain cost-savings. Win-win situation both for pure FS companies and for the subcontractors? Unfortunately not, when value-added tax (VAT) is introduced into the business calculations of outsourcing’s costs.

Let me explain. Financial services are exempted from VAT which should be a blessing for banks and other FS companies but in reality this creates an extra problem arising from the very nature of the exemption: it does not only mean that the supplies of banks and other FS companies are exempted from VAT but it also means that these same companies cannot deduct the VAT included in their own purchases. In essence, when a business application of a bank will be  run by a subcontractor, the invoice arriving from the subcontractor includes VAT that will be a cost for the bank due to bank’s limited VAT recovery rights.

As outsourcing services will often mean an extra VAT cost, it’s no wonder that it is historically common in the FS industry to produce lot of the IT services in-house even though those services are clearly not within their main line of business and that there would be willing and capable IT companies to produce these support services more effectively. And they say that VAT should be neutral tax and not effect business decisions nor business landscape!

The “mismatch” between VAT and FS industry is not new and there has been traditional solutions to mitigate the VAT problem. The solutions have either allowed certain IT and other services to be outsourced without a VAT cost by considering them as financial services in itself (doctrine based on European Court of Justice’s decision on case C-2/95, SDC) or by exempting certain supplies within interest parties (e.g. VAT groups and cost sharing groups).

Unfortunately, the recent trend in European VAT has not been too positive for FS industry and the effectiveness of these traditional solutions is diminishing. For instance, there is a pending case at the European Court of Justice which could potentially completely shut out FS industry from utilizing cost sharing group exemption. Furthermore, Finnish VAT practice has become really austere regarding the conditions under which the FS-related services outsourced to an IT company or other subcontractor can be considered as VAT exempt financial services, making IT service provider’s and subcontractor’s sales efforts harder as their services include an extra cost component from the purchaser’s point of view. Therefore, the current view is that the VAT system is not really supporting the general development and transformation of the financial industry but hindering it – which is the contrary to the original purpose of the exemption.

Yet, the situation is not too gloomy and the digital transformation in the way how FS services are being produced does offer new possibilities to mitigate the VAT costs related to outsourcing of services and revised production chains. For example, when larger and larger part of the FS companies’ operational softwares and systems are being outsourced in the production chain, this gives leverage to claim that the outsourced services do constitute an independent VAT exempt financial service in itself. Such solutions are already applied e.g. in the card payment business. Further, also the traditional structures like VAT groups and VAT effective bundling of services into VAT exempt entity do still have their places.

I encourage FS companies and IT service providers to seek for innovative, effective and mutually beneficial business models but would like to remind of the need to analyze the intended business structure in advance from VAT point of view. If appropriately handled, VAT does not always need to be a final cost even in the FS industry.


Lassi Ahopelto
Financial Services VAT

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