Payment Processing and EU VAT
A practical guide and overview
The payment industry is changing rapidly due to e.g. new technologies and business models. However, the EU VAT-system has not seen any real reform since its introduction in the 1970s. The outdated rules often lead to uncertainty, various tax practices across the EU and distortive tax burdens. A wide and flexible option-to-tax for businesses is needed to create a future-proof EU VAT system
VAT exemption for payment transactions
Some financial transactions are exempt from VAT. This may sound great, but there is a downside: taxpayers who provide exempt supplies are not entitled to recover input VAT on their costs. Whereas VAT is usually neutral, it is not neutral at all for taxpayers with VAT-exempt activities. The irrecoverable VAT is usually passed on to customers through an increase of the price of exempt supplies (“hidden VAT”). Generally, B2B businesses are better off with a VAT-taxable treatment than with a VAT-exempt treatment. Why? Business customers can generally offset the VAT, so it does not come as a cost to them, and VAT taxable treatment allows the supplier to offset VAT on its own costs, so there are no hidden VAT costs.
In the past, card-based payments were processed by traditional banks and were considered as exempt payment transactions. With the arrival of e-commerce, payment service providers (PSPs) took over part of this role and started routing transaction data between merchants and acquirers – the so-called “gateway services”. These services are generally seen as “mere technical services” that are not in scope of the exemption.
VAT-taxable debt collection
Based on case-law from the European Court of Justice, it could be argued that merchant acquiring services that are provided by acquirers and PSPs to merchants constitute VAT-taxable “debt collection” services. We could even argue that other parties that are involved in processing card-based payments (e.g. card scheme and card issuer) should also be treated as VAT taxable. In the Netherlands, merchant acquiring is considered as VAT-taxable debt collection. Some other EU member states (e.g. Germany and Belgium) have implemented the “option-to-tax” for payment transactions, which allows businesses to opt out of the VAT exemption – under detailed conditions. However, in most other countries, merchant acquiring services are still mostly considered as exempt payment transactions, with the VAT exemption resulting in hidden VAT costs.
The payment industry will keep changing rapidly. New players, such as FinTech companies and the big tech companies, will soon enter the market – or are already doing so. Cryptocurrencies are becoming a new means of payment. And open banking, facilitated by new regulation such as PSD2, will enhance change and innovation even more. Unfortunately, the current outdated VAT system cannot accommodate these changes properly, causing uncertainty, disputes and various VAT practices across Europe. What we need, is a full overhaul of the VAT exemptions for financial services. A wide and flexible option-to-tax for businesses can solve many issues in B2B. It might take years before we get to this point, but that is what we need to agree upon if we want to create a more robust and future-proof EU VAT system.
The Future of Banking
Over the last few months we have been sharing a range of articles with you on the future of banking, based on the ‘seven wicked problems’ we have identified. Our research skills and day-to-day experience in working with banks have allowed us to dive into these challenges more deeply. By sharing our insights, we strive to help you with the choices you face in your day-to-day work and with aligning your leadership, culture and organizational structure to a fully digital mindset, optimizing the use of proprietary and external data. Sign up for the email alerts to make sure you won't miss any of the articles about the latest insights and solutions on the future of banking.