How the EU VAT exemptions impact the banking sector

New research by Professor Ben Lockwood of the University of Warwick undertaken with PwC has revealed that the VAT exemption which applies to European banks does not lead to a tax advantage for the banking sector. The report concludes that if bank services were subject to VAT (in place of the current exemption system) this would not lead to any significant increase in EU VAT revenues.

The report sets out in detail why the VAT exemption applying to banks does not lead to a tax advantage for banks. Under the current VAT exemption system, banks do not charge their customers VAT, but in return they cannot recover VAT on costs they incur. In the report, this irrecoverable VAT is estimated to amount to up to €33bn per annum.

VAT is meant to be a tax on final consumers and the VAT exemption for banks moves away from this principle by imposing the irrecoverable VAT on the banks themselves. One reason for this is the difficulty of imposing VAT on the value added by banks and charging customers. If EU banking services were to become subject to VAT, banks would be able to fully recover the VAT on their costs and EU government revenues from this source would decrease. While banks’ customers would be charged VAT, business customers would recover this so that government VAT revenues would only increase by the amount of VAT on non-business (or non-VAT registered) services to customers of banks.

The report finds it unlikely that the VAT raised from consumers would be significantly higher than the tax governments would lose because banks would recover VAT on their costs. Indeed, on some analysis, overall EU VAT tax revenues could even decrease as a result of imposing VAT on banking services. For this reason, the report concludes that the VAT exemption cannot be considered as giving rise to a tax advantage for the EU banking sector.