Outsourcing is the process by which organisations contract-out certain non-core internal functions to third party suppliers to perform, thus achieving cost-savings and focus on core competencies. Examples would include outsourcing cheque clearing activities, packaging mortgage applications, credit card data investigation and account query resolution or back-office settlements and accounting.

VAT issues play a critical part in the decision to outsource because if ignored increased VAT costs can negate some of the efficiencies achieved through outsourcing. The outsourced service being provided back to the financial institution must be a VAT-exempt service when supplied separately in isolation in order to remain VAT-free. For example, cheque clearing activities are an integral part of a bank’s normal operations and subsumed within its overall activities. However, when the outsourced serviced is provided by an outside contractor to the bank, care needs to be taken to ensure VAT costs do not arise as a result of re-categorisation of the service to the partially-exempt financial institution. Such a situation arose in the Sparekassernes Datacentre (SDC) case where similar activities were outsourced to a service provider owned by a consortium of Danish banks.

Provision of outsourcing via the Internet accentuates the problem by further removing the third-party service provider from the final customer both in terms of geographical remoteness as well as in terms of web-based contracts limiting legal liability to the end user. This increases the risk that the outsourced service will be perceived as standard-rated than would otherwise be the case if the service were provided directly by the financial institution to the end-user.

Planning opportunities might include aggregating potentially standard-rated services from the Outsourcer with other services so that the overall nature of the outsourcing assumes an intermediary role. It may also be possible to provide the outsourced service to a part of the financial institution whose activities are mainly taxable. Proper and timely VAT planning is therefore essential to ensure that the cost-saving benefits of outsourcing are not negated by increased VAT costs.