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HMRC internal manual

VAT Partial Exemption Guidance

HM Revenue & Customs
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Guidance for specific trade sectors: insurance companies


The problem

The investment activity of an insurance company is not an incidental activity for the purposes of any partial exemption calculation. However, such supplies will normally have a distortive effect on a values based partial exemption calculations.

Policy on PE methods in this industry

Values based calculations

  • The sales of securities are distortive when they are included with other sorts of supply in a single values-based calculation. This is because the supplies are proportionately high value relative to the amount of input tax they incur.
  • Pound for pound, premium income consumes much greater amounts of overheads as dealings in securities.
  • Accordingly, our policy is that the sales of supplies of securities should generally be treated as a separate sector in any partial exemption method. Likewise it would normally be appropriate to have a separate sector for rental income.

Other calculations

  • In the circumstances we would consider alternative means of identifying the recoverable input tax relating to such transactions.
  • For example, residual input tax could be allocated using for example management accounts to business areas (sectors)

Tribunal decision in National Providence Institution (NPI)

The NPI case concerned recovery of input tax by an insurance company that made supplies of securities outside the EU.

NPI made three sorts of supply for VAT purposes:

  1. Taxable supplies of property (which it had opted to tax)
  2. Exempt supplies of insurance (pensions, life assurance & annuities), exempt supplies of securities in the UL and the EU, and
  3. Specified supplies of securities outside the EU.

Because NPI did not have a special method it needed to make the apportionment of residual input tax in two stages.

  • a calculation under regulation 103 to determine the input tax used in making specified supplies (See PE34000 - Regulation 103: Recovery of input tax attributable to foreign and specified supplies).
  • an apportionment between taxable supplies and exempt supplies under the standard method.

As stated in PE34000, officers can agree a single method that includes both of these stages, provided this gives a fair and reasonable result. NPI sought to use a single value based calculation. NPI used a single value based calculation that had not been approved. The Commissioners raised an assessment using a staff count to split the input tax between premium income and investment income. They then used a values based method in each sector.

The Tribunal reviewed the evidence and found that found that the method was unsafe because there was no clear relationship between the overheads and staff numbers. No other method was put to the Tribunal by either side, which meant that in the circumstances the Tribunal had to choose between the calculations put forward by each party. The taxpayer’s method was using a simple values-based method was favoured over the method used by the Commissioners.

HMRC decided not to appeal the decision because it was made on the facts of the case. However, they do not consider that a values-based method gives a fair and reasonable result for this type of business.

Cost components of insurance supplies

Deutsche Ruck (ref CO/2483/93), concerned a contract of reinsurance. The taxpayer received a supply of legal services in order to quantify a claim made under that contract. The High Court decided that the expense concerned was a cost component of the reinsurance service.

When applying the Deutsche Ruck principles to the supply of insurance, HMRC consider the expenses incurred settling a contract of insurance to be a cost component of the supply even though they are incurred long after the premium has been paid. This follows the ECJs approach in Midland Bank plc [C98/98].

Pension mis-selling expenditure

In recent years a number of insurance companies have incurred costs in correcting mis-selling of policies to customers.

In our view, pension mis-selling costs are an overhead of the taxpayer’s pension products and form part of the cost components of those products. The costs are not used for the purposes of making supplies of securities or property and do not form any part of the cost components to those supplies.

Lloyd’s VAT arrangements

The text of the current arrangements as of January 2004 is annexed at PE77000.

Partial Exemption Guidance for the Insurance Sector

Additional guidance has been written and compiled jointly by the Association of British Insurers (ABI) and HM Revenue and Customs (HMRC) intended to help insurers gain approval for a fair and reasonable Partial Exemption Special Method (PESM) with the minimum of cost and delay.

The additional guidance can be found on the GOV.UK website