Insurance companies are bracing themselves for a massive hike in their tax bills following a landmark ruling from the European Court of Justice, according to accountants Ernst & Young.
Under the ruling, insurance companies will be forced to pay VAT on certain services that have been provided by an outsourcing company, including the acceptance and checking of insurance applications, policy changes and claims management.
And it is likely that some, if not all, of the increased tax costs will have to be passed on in the form of increased insurance premiums.
The controversial ruling concerns services provided by Andersen Consulting Management Consultants covering a wide range of outsourced 'back office' functions for Universal Leven.
Under the European 6th VAT directive, VAT exemption applies to the provision of insurance, including 'related services' carried out by brokers and agents - Andersen had contended that its services fell under this exemption, but the ECJ, backed by an earlier Advocate General's opinion, has ruled that VAT must be paid.
Peter Jenkins, global head of indirect tax at Ernst & Young, said: 'This ruling will have a massive impact for many businesses operating in the insurance industry, particularly outsourced service providers providing administrative and other back office services to the insurers. It will hit margins and force up premiums, or turn profitable contracts into loss makers.
"The nub of the issue is the difference between outsourcing and intermediating - the former involves subcontracting functions that were historically performed by the insurer and the latter a function historically undertaken by brokers and agents.
"Earlier cases have taken the view that services carried out by a supplier for an insurer are not VAT-exempt if there is no direct relationship between the service provider and both the policy holder and the insurer. The ECJ would appear to have applied this conclusion here, even though ACMC was able to accept new insurance business on behalf of UL, as well as managing claims and contracts."