Banks and insurers in Europe are bracing for extra value added tax bills that could potentially run into billions of euros after an
unexpected decision from the European Court of Justice.

The ruling on a dispute between Skandia America Corporation, a US arm of the insurer, and the Swedish tax authority means that
services supplied between a group's headquarters and its branches are set to be subject to VAT.

Stephen Morse, a tax partner at PwC, said many financial services companies operating in Europe would see their VAT bills soar. He said
individual charges for the biggest banks and insurance firms could rise by tens of millions of euros. "The case significantly expands the
VAT net for financial services firms. Banks and insurers are likely to be affected most," he said.






The ruling means that previously VAT-free services will now be subject to the tax ­ at rates of between 15 and 27 per cent. The industry
will not be able to recover the VAT charges in the way other businesses can as they are deemed to be VAT exempt, resulting in significant
extra costs for the firms.

The ruling concerns the costs shared between the head office and its branches in other countries, which will now become liable to VAT.
Until now, European VAT law allowed countries to treat companies and their overseas branches as single entities for VAT purposes.

The case is expected to affect 15 member states but is thought to have the biggest impact on the UK because of its large number of foreign
headquartered financial institutions and the widespread use of offshoring. Advisers said it would cost financial institutions hundreds of
millions of pounds in the UK alone.

Richard Iferenta, head of financial services indirect tax at KPMG in the UK, said: "What this ruling does is, at a stroke, add hundreds of
millions of pounds to the annual cost of financial institutions doing business in the UK and other EU member states.

He added that "with the UK's position as a global financial services centre and the consequential level of inward investment into the UK by
foreign financial services business that flows from that, the financial impact of the judgment may be felt hardest in the UK."

Tax authorities across the EU will now consider how they implement the rules. The UK's Revenue & Customs said: "HMRC is considering
whether the judgment has any application to UK grouping provisions, which are different to those in Sweden".

Advisers said there was little doubt that the UK would implement the ruling, despite having argued that its existing rules, which included
anti-avoidance measures, were consistent with EU law.

The ruling will force financial institutions to review the services they are buying in from outside the EU and possibly make changes to
reduce the impact of the change. But advisers said that restructuring was unlikely to help companies avoid higher taxes altogether.






The decision came as a surprise to the industry, as it did not follow the earlier opinion issued by the court, which is usually an indication of
the final decision.

The case was triggered by a decision by the Swedish tax authority to charge VAT on the supplies of IT services from Skandia America
Corporation in the US to its Swedish branch.