In an article that was first published in Finance Dublin, Gavin O’Connor discusses the future of financial services in the aftermath of the Skandia America judgment. While the Court of Justice of the European Union’s decision is a hugely significant case, the impact on many financial services firms will most likely be limited. However, the judgment could mean that cross-border intra entity transactions which were previously disregarded may now be subject to VAT, and may necessitate system changes by companies, including aircraft lessors, to ensure transactions are correctly recorded.

Much has already been written about the recent judgment of the Court of Justice of the European Union (‘CJEU’) in the case of Skandia America Corporation USA, Sweden branch (C-7-13) with many commentators stating that the case could cost potentially billions of euros for financial services companies operating in Europe.

As always the truth is more complex and while there is no doubt that it is a hugely significant case, for many financial services companies the impact, if any, will be limited. For other companies who could potentially be significantly impacted by the judgment there are many steps they can take to mitigate potential negative impacts.

The purpose of this article is to summarise for a non-tax professional the decision of the CJEU and the practical steps companies can now take to address the potential implications.

Background

Skandia America Corporation (‘Skandia’) was the global purchasing company responsible for procuring IT services for the wider Skandia group. It was established in the US and carried out its activities in Sweden through its Swedish branch. Skandia received externally provided IT services from US providers and recharged these to its Swedish branch. The branch used these services to make onward supplies of IT services, both inside and outside the Swedish VAT group.

Skandia contended that no VAT arose on the intra-entity supply of IT services from Skandia to its Swedish branch. In taking this view Skandia was relying on the 2006 decision of the CJEU in FCE Bank (C-210/04) where the Court held that transactions that take place within the same legal entity, for example between head office and a branch or between different branches of the same entity, do not give rise to supplies for VAT purposes.

In contrast, Sweden argued that VAT should be (reverse) charged on the supply of IT services from Skandia to its Swedish branch.

The judgment

The Court confirmed that the FCE Bank judgment applies and therefore that services provided from a head office to a branch continue to be disregarded where the branch is registered for VAT in its own name and is not in a VAT group.

However, the CJEU held that where a branch joins a VAT group it is precluded from being identified as an individual taxable person. As a result, the supply from within that entity to the branch must, for VAT purposes, be treated as no longer supplied to the branch but to the independent VAT group of which the branch forms a part.

The CJEU stated that since ‘the services provided for consideration by a company such as [Skandia] to its branch must be deemed, solely from the point of view of VAT, to have been provided to the VAT group, and as that company and that branch cannot be considered to be a single taxable person, it must be concluded that the supply of such services constitutes a taxable transaction’ and that the reverse charge mechanism must be applied to that supply.

The potential impact of the decision

Effectively the decision has ruled that certain cross-border transactions between head-office and branches will now attract VAT. This has a real, above-the-line cost for FS businesses as typically not all VAT is recoverable. Accordingly, the case is expected to have a significant impact on banks, insurance and certain asset management companies operating in Ireland given their typical organisational structures.

In particular, the type of services which could be impacted would include the following:

• finance, human resources, IT, marketing and management services provided by head office
• back and middle office support services provided by shared service centres and centres of excellence
• technology and research services consumed by the front office
• recharges of third party costs purchased on a branch’s behalf by its head office

In addition, while the potential impact for financial services companies that cannot recover VAT in full is clear, what is less appreciated is that the case could also have an impact on businesses that are engaged in fully VATable activities, for example leasing companies. Although companies in these sectors will typically be entitled to recover VAT in full on costs (and therefore the case will not result in an above the line cost), cross-border intra-entity transactions which were previously disregarded may now be subject to VAT. This may necessitate systems changes to ensure that the transactions are identified and recorded in VAT and VIES returns.

Uncertainties remain

Although on an initial reading of the judgment the view of the CJEU seemed clear, now that the dust has settled and taxpayers are considering the impact on their specific situations considerable uncertainties remain.

In particular, the CJEU in Skandia (as in any other case) only addressed the specific fact pattern. Furthermore, the actual legal analysis and reasoning set out by the CJEU supporting the decision was brief. As a result, it is not entirely clear whether the Court would come to the same conclusion for other head office to branch transactions where the fact pattern is different to Skandia. These uncertainties are amplified by the differences in legislation and practice between EU Member States and the uncertainties as to how different Member States will implement the decision.

Some of the many open questions include the following:

• Member States are taking different approaches to implementing Skandia. For example in Ireland we understand that the Revenue Commissioners have indicated that they will carry out a full assessment of the potential impact of the Skandia case (which we expect will include listening to industry submissions) before making any changes to the current arrangements. This approach can be contrasted with the Netherlands where the Dutch authorities have indicated that they will implement the Skandia decision (taking a broad interpretation) with effect from the date of the judgment on 17 September 2014. These differences lead to additional uncertainties for taxpayers. For example, if an Irish branch (in a VAT group) is supplying services to its Dutch head office should it report the transaction in its VIES return when the transactions is disregarded for Irish purposes but is viewed as a taxable supply in the Netherlands?
• Irish (and indeed UK VAT legislation) is different from the VAT legislation in Sweden. Under Swedish legislation it was clear that only the Swedish branch (and not the US Head Office) was part of the Swedish VAT group. Irish VAT legislation is different and states that each “person” is in the VAT group which means that under Irish legislation there is a strong argument that the head office is part of the Irish VAT group. Under this analysis supplies from third parties would be subject to VAT but internally generated supplies between members of the VAT group (including the overseas head office) would not be subject to VAT. It is also notable that the UK tax authorities have specifically stated that they will take into account the differences between UK and Swedish legislation when considering the impact of Skandia. It will be interesting to see whether Irish Revenue take a similar approach.
• The Skandia case addressed a scenario where the services were supplied from a head office overseas to a branch that was a member of a local VAT group. The Court did not specifically address the reverse scenario in which services are received by a branch that is not in a VAT group but the head office is in a foreign VAT group. One interpretation of Skandia is that this shouldn’t make a difference – if either the head office or branch is in a VAT group then the supply cannot be disregarded. However, such an interpretation would mean that the tax authority in the location where the non-VAT grouped branch is established would be required to take cognisance of whether there is a VAT group in another jurisdiction. It is by no means clear that the Court intended such a consequence.

In view of the uncertainties described above all potentially affected businesses will eagerly await the response of the Irish Revenue Commissioners’ and other EU authorities in order to clarify matters. However this does not mean that companies should wait to see how tax authorities implement the case. Instead, companies should now begin the process of identifying the potential impact and examining solutions.

What can companies do now?

The most important initial step that companies can and should do is to assess the potential impact on their organisation. This initial assessment would involve a high level review of all intra-company flows as follows:

• Tax and finance teams would work together to map all relevant intercompany transactions capturing details of the nature of the services, the value and location of the supplier and recipient
• The mapped data would then be analysed by applying VAT logic to each transaction. This would enable the organisation to quantify the headline potential VAT costs
• The organisation could then focus on and prioritise the transactions where solutions are required. The potential solutions could then be explored with the business functions, preferred options identified and feasibility determined.
• This initial assessment would enable companies to identify where the potential significant costs could arise and to begin examining the feasibility of different solutions.

While the manner in which each organisation will address the potential impacts is different (and will be partially determined by how each Member State enacts the decision), some of the concepts that companies are now examining include the following:

• Is a VAT group the most efficient way of structuring the group’s affairs? For example, where the value of head office / branch supplies is large it may be beneficial to remove the branch / head office from a local VAT group.
• Is it feasible to establish a cost sharing group on a pan-European basis? The establishment of a cost sharing group, subject to certain conditions, enables supplies between members of the group to be supplied exempt from VAT.
• Are VAT exemptions being maximised? Previously the VAT rate applicable to certain head office / branch transactions may not have been considered in detail as the transactions were disregarded. If the transactions cannot be disregarded the services should be examined in detail to determine whether any of them qualify for VAT exemption in their own right.
• Where transfer pricing adjustments are made in the direct tax returns, i.e. no actual payments are made between a head office and its branch, can it be argued that the tax base for VAT purposes is nil?

Summary

The Skandia case is undoubtedly one of the most significant VAT cases for many years for financial services organisations. Uncertainties remain, not least how the Irish Revenue Commissioners and other Member States will implement the decision. However, there are many practical steps companies can take now to mitigate the potential impact of the decision, even if the Irish Revenue were to take a broad interpretation of the case.