Posted: 06 Jun. 2023 5 min. read

Fintech VAT Top Tips - March 2023

Fintechs may be missing out on VAT recovery

Fintechs often incur significant amounts of UK VAT on purchases throughout their lifecycle, from start-up to more mature phases – either directly from UK suppliers or by virtue of the requirement to self-assess for VAT under the reverse charge (as covered in our previous article).

Fintechs usually make some level of VAT exempt supplies and are therefore partly exempt for VAT purposes. This means that VAT incurred on purchases cannot be recovered in full, creating an additional irrecoverable cost for the business on top of its normal cost base. This can be particularly unhelpful for a new growing Fintech and in an environment where funding options have narrowed.

This article outlines some of the options available for Fintechs to enhance or improve VAT recovery, and hence reduce their P&L cost. In our experience, often these are missed, resulting in businesses leaving VAT recovery potential on the table.

Specified Supplies – what does this mean for me and how do I spot it? 

The Specified Supplies Order 1999 (“SSO”) permits UK VAT registered businesses to recover input tax on exempt insurance and financial services (excluding special investment management) where they are supplied to customers outside of the UK (or non-EU customers for periods prior to 1 January 2021).

This means that if a UK VAT-registered Fintech supplies VAT exempt financial services (excluding investment management) to customers located outside of the UK, it will be able to recover the VAT incurred on the direct and residual costs that relate to those supplies. These supplies in effect will be treated like zero-rated taxable supplies, so no requirement to account for output UK VAT, but with an entitlement to recover input VAT.

Where this has incorrectly not been applied by a business, this can result in a substantial retrospective VAT claim for up to 4 years. For example, we have seen UK Fintechs treat all input tax as irrecoverable on the premise it only made exempt supplies that do not give a right to VAT recovery, when in fact it had customers based outside of the UK (e.g., Norway, Switzerland, the Channel Islands etc.) with an entitlement to submit a retrospective VAT claim.

We are also aware of a number of established businesses that have rightly factored in recovery for supplies to non-EU customers pre-Brexit, but then did not identify that the scope of the SSO provisions had been extended to supplies to EU customers from 1 January 2021.

Start-up Fintechs – Should I be using turnover as a recovery proxy?

The input tax recovery rules are intention-based and entitle a business to recover VAT incurred that has been used to make both taxable or intended i.e. future, taxable supplies. This is particularly relevant for Fintechs in a pre or low revenue development or growth stage, where the business may be incurring high costs and associated amounts of VAT in respect of an intention to make future supplies, but they are not yet making any supplies or they are not fully developed, so current income streams don’t fully reflect the true current intentions.

A classic example of this we see in the sector, which results in VAT recovery being missed, is where a business has a dual business plan to both develop a VAT exempt direct to consumer (“D2C”) Fintech business model (e.g., relating to the making or introducing of loans, investments, or payments services), but is also developing underlying software and technology with a view to making taxable supplies to other third-parties. Often the initial emerging revenues will be VAT exempt from the D2C business, so a VAT recovery calculation based solely on revenue will result in no VAT recovery, whereas the costs of the business are actually being used and consumed to develop both that current exempt income and also the future intended taxable business. Provided there is really good evidence of the use of costs in relation to the future intention, it should be possible to agree with HMRC an underlying recovery that reflects this and this can significantly increase VAT recovery. Where this opportunity has been missed, potentially this can be corrected through retrospective adjustments.

HMRC are naturally more challenging of intention-based recovery as it can be difficult to understand and substantiate, but the rules are clear, and with the right evidence significant cost reductions can be achieved.

Bespoke recovery methods

For some Fintechs, the standard turnover partial exemption method is appropriate and accurate for calculating VAT recovery. Broadly speaking, it allows VAT incurred on general overhead costs to be recovered in proportion to the value of taxable over the total value of supplies made by a business. It has the benefit of not requiring approval, being straightforward, and is the method preferred by HMRC.

However, for many, it is not fit-for-purpose, especially where the relative level of costs and VAT used and consumed in relation to the income streams of the business varies. In this case, a business has two main points to consider:

If the difference in VAT recovery between the standard method or an alternative use-based method is substantial, then the business is required to apply a standard method override (“SMO”) to adjust the amount of input tax recovered on an annual basis. An adjustment could potentially be made on this basis for the previous 4 years.

The business can also agree a bespoke recovery method (a Partial Exemption Special Method (“PESM”)) with HMRC, which may be backdated to the start of the partial exemption year and can allow a business to achieve certain ongoing VAT recovery benefits.

Residual recovery vs. Direct attribution

Direct attribution is a mandatory requirement of the VAT rules, which means that VAT on costs that are used exclusively to make a particular supply must be attributed to them for VAT recovery purposes. For example, if a software license relates to software that is only used to make a taxable supply of marketing services, the VAT can be recovered in full. Conversely, if a cost solely relates to an exempt supply that does not give the right to input tax recovery, the VAT thereon is wholly irrecoverable. Due to the administrative complexity of this process, we often see Fintechs simply treat all input tax incurred as residual so VAT is only recovered at the overall partial exemption recovery rate. Sometimes, depending on the nature of the business this can be supportable, however it can also result in an under recovery of VAT.

A specific example we have recently seen is a business incurring marketing costs that exclusively related to a non-UK activity financial activity. The business had just treated the costs as subject to fairly low residual recovery, whereas it should have been directly attributed to the taxable overseas supply and recovered the VAT in full.

I think this is relevant to my business, what should I do?

Please get in touch if you are concerned about the level of irrecoverable VAT cost your business is incurring. We have a dedicated Fintech VAT Advisory team with a wealth of experience in realising input tax claims for Fintechs and enhancing VAT recovery. We are always open to a call to discuss opportunities and issues we are seeing in the market.

Author:

      

            

Adam Richardson
Associate Director - VAT, Deloitte

Authors

Dave Taylor

Dave Taylor

Director

Dave is a Director within Deloitte UK’s Financial Services & Insurance team. He leads the indirect tax proposition in relation to FinTech businesses, involving the consideration of how technology is disrupting the industry. He is also the UK subject matter expert for digital assets and cryptocurrencies. Dave advises clients on the VAT and IPT impact of their supply chains across the industry, but most significantly in the payments, digital banking and insurance sectors. He works closely and extensively with colleagues in transfer pricing, regulatory advisory and legal to provide clients with holistic support in bringing their products and services to market both domestically and internationally. Recent projects including advising clients on the treatment of payment-related services, the determination of VAT recovery methodologies, electronic intermediation of lending/insurance products, and the issuance and trade of NFTs and other digital assets through online platforms.

Eric Gilvray

Eric Gilvray

Associate Director

Eric is an Associate Director with the Financial Services Indirect Tax team in London, UK. He specialises in advising Financial Services businesses on indirect tax compliance and advisory matters. Eric takes a keen interest in the Investment Management and Fintech sub-sectors within FSI and has been assisting the UK practice lead up the VAT digital banking offering.