Financial services such as payment and settlement services, granting of credits, and currency exchanges are generally exempt from VAT. This means that no VAT is charged on the price of these services. For example, the fee charged for processing a payment transaction is exempt from VAT (to the extent no option to tax has been invoked) and therefore it initially appears cheaper than when VAT is applicable. However, based on the fundamental principles of the VAT system, the provider of exempt services is not able to deduct the VAT paid for the goods and services purchased (i.e. input VAT) for supplying its exempt services. Consequently, the service provider will usually include the non-deductible input VAT into the price of its services, which makes the price higher and distorts economic neutrality.
Scope of VAT exemptions for financial services
The VAT exemptions for financial services under Belgian legislation are based on EU legislation. The relevant provisions of the EU VAT Directive were first introduced in 1977 and are quite concise. They leave room for different interpretations in Member States and offer also the option to subject services to VAT. The arguments for exempting financial services from VAT included the alleviation of the difficulties in determining the tax base and the amount of deductible VAT, as well as the avoidance of increased costs of consumer credit.
While the VAT exemptions have basically remained the same since their introduction, the digitalization of the financial sector and our society has profoundly changed the nature of financial services. At the time of their introduction, the financial sector operated very differently – credit was primarily granted by banks and payments were typically made by bank notes. There were no peer-to-peer lending facilities nor electronic payment facilities, cryptocurrencies or multi-purpose vouchers. In this new context, the concise wording of the VAT exemptions is hard to interpret and their scope of application is difficult to determine. In practice, it is challenging to establish whether the nature of a service is more an IT service (VAT-taxable) or an IT-driven financial service (VAT-exempt). While tax authorities in EU Member States provide some guidance, these may contain slightly different interpretations and lead to slightly different results. In a cross-border context, the mismatches in interpretations may then offer tax planning opportunities and distort competition between service providers, creating an uneven playing field.
Payment services are a good example of where current taxation policy needs to be updated. Nowadays, payment transactions have a highly digitalized process and there are different electronic payment facilities (e.g. PayPal, Bancontact, ApplePay) available. Payment transactions are no longer primarily done by banks, but are also processed by FinTech enterprises and other IT-companies, including mobile telephony providers. The services of banks are traditionally exempt from VAT (to the extent no option to tax has been invoked) as opposed to those of new service providers, which are often treated as VAT-taxable technical (electronic) services. However, because non-deductible VAT has a cost-increasing effect on outsourcing and investments, it is more beneficial for service providers to have their services treated as VAT-taxable and, consequently, be able to deduct the input VAT. This is even more important for EU service providers – established in countries where no option to tax is available - that can have a competitive disadvantage compared to those established outside the EU, where no comparable VAT system applies. Revision of the VAT treatment of payment services at EU level is therefore crucial for the sector.
Approach for the future
The question of VAT treatment of financial services had already prompted the European Commission to propose new legislation in 2007. Member States were unfortunately not able to reach an agreement on the proposals and these were withdrawn in 2016. As a result, divergences between Member States remained, while the variety of financial services continued to increase. Given these and other developments, the European Commission decided in 2019 to initiate a study on the functioning of the VAT rules for financial services in order to be able to decide whether EU action is needed and, if so, which is the best way forward. Furthermore, on 22 October 2020, the European Commission published a Roadmap on this matter whereby feedback from stakeholders is requested by 19 November 2020 to determine further developments[1].
In other parts of the world, such as China, Israel, Argentina and India, financial services are, in principle, taxable and models exist that put traditional financial institutions on an equal footing with new entrants in these markets.
Taking into account the above aspects, if you could advise the Belgian government and the European Commission on the VAT treatment of financial services, would you recommend that these services be subject to VAT? Would you take the same position when you consider, for example, that you as a customer would then initially pay a higher fee for a payment transaction because it is subject to VAT, which you cannot deduct?
VAT treatment of financial services by 2025
The maintenance of VAT exemptions for financial services may be conceivable for logistical, fiscal or financial reasons – such as in the case of granting of mortgages, or insurance premiums subject to other taxes. However, the vast majority of financial transactions are likely to be subject to VAT in the near future. Comparable services of banks will then be treated in the same way as those of new IT-driven service providers, such as payment service providers, cryptocurrency miners and FinTech enterprises. Considering the complexity of the issue and the need for an EU wide consensus on the (new) VAT treatment of financial services, it is questionable that financial services will be subject to VAT in the EU and in Belgium by 2025.
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Author: Benoît Pernet, Partner
The VAT system in Belgium was introduced in 1971, which will be 50 years ago in January 2021. On this memorable anniversary, KPMG Tax & Legal Belgium and Wolters Kluwer jointly publish a series of articles that reflect on the current VAT system in the context of our changing business and social environments. In each article, KPMG tax experts address a specific aspect of VAT and related challenges of the system and offer predictions on future evolutions by 2025.
