The European Court of Justice has recently decreed that insurance companies will now have to pay value added tax on certain services provided by outsourcing companies, including the acceptance and checking of insurance applications, policy changes and claims management. This ruling has stirred much debate, with experts wondering how it will affect the insurance industry and even outsourcing as a whole.
According to tax adviser and accountant Ernst & Young, most if not all of the increased tax costs will most likely be passed on to customers in the form of increased insurance premiums.
Given outsourcing by its very nature is dynamic and adept to change, the overall impact of this ruling on the outsourcing industry will be almost negligible, as most outsourcing contracts already require the customer to pay VAT.
But some commentators believe the ruling may hit many businesses in the insurance industry, particularly those involved in outsourcing service providers offering administrative and similar back-office services to insurance companies.
But this would, in my view, appear to be a somewhat limited opinion. This is because the ?VAT issue? has been one of a few key drivers for transitioning business processes offshore ð principally to Asia, where there are certain noteworthy points to consider. For instance, conventional outsourcing (where the service is delivered from the same economic region) can at best hope to attain from 20% to 35% reduction in operating costs. Also, any added VAT at this level ð as well as many of these efficiencies for that matter ð becomes negated as absorbed through tax. Therefore, the availability of upwards of 65% cost reductions from offshore work renders the service more economically viable even with a VAT charge included.
Similarly, the ruling will serve to strengthen the case for the transition of business support processes offshore in the insurance sector.
There is a long way to go in terms of governments ð both domestic and European ð deciding how to confront the globalisation of business services. Currently the expectation is that a non-protectionist stance will be adopted having learned the hard lessons (from the globalisation of manufacturing) of how protectionism, in the long run, damages domestic competitiveness.
It is not inconceivable, however, that those European nations involved may seek to minimise the impact on employment and stem the tide by implementing measures that render it easier and economically attractive to source purely within the Eurozone.
This can be achieved by reducing or even abandoning VAT type charges on certain outsourcing contracts as one such measure. In any case, the long-term availability of business services globally will competitively overcome such manoeuvres.
The question is will this ruling have any effect on management consultants and their roles? Management consultants advising on outsourcing deals must assist clients in pursuing the safest and highest levels of efficiency as possible, regardless of the sourcing locations used to surpass VAT and deliver meaningful value to the client.
They must also remain fully abreast of global locations and providers from which insurance support services are available or may be delivered from. Our strategy and perhaps that of other firms, embraces globally sourced business services in all sectors to attain the highest efficiencies possible and the VAT ruling serves to strengthen the case for this. Moreover, our approach along with many of our counterparts, to the design of commercial arrangements is fully flexible as it possesses a number of innovations that financially assist the insurance customer in meeting its VAT obligations.
On the whole, this ruling brings into sharp focus the need to comprehensively re-examine the corporate and legal frameworks in place within the developed economies. This will be especially true of sectors and companies that are restructuring at fundamental levels, and as globalisation and more focused enterprises divest and exit many traditional activities such as claims handling and policy administration in the insurance sector.
In addition, traditional definitions of the differences between intermediation and third party support services now require a wide ranging review and debate among all stakeholders (and possibly revision), as business services providers assume the primary responsibilities for servicing the end customer or policy-holder.
Kirk Smith is a management consultant at LogicaCMG?s outsourcing practice
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