Brokers and insurers could be hit with five-figure penalties from HM Revenue & Customs (HMRC) under proposed changes to the partial exemption tax regime.
From April 2007, HMRC will be given the power to penalise those businesses that make both taxable and exempt supplies, and operate a partial exemption method to calculate the VAT they can recover on their costs and purchases.
Financial services companies are prone to problems in this area.
Under the changes, the government department could demand £100,000 or more, plus interest, if it deems that the method used to calculate recoverable VAT was not "fair and reasonable".
Paddy Behan, VAT director at financial and business tax advisers Grant Thornton, told Insurance Times: "You could go two or three years down the line and if a change is made to your business and it results in a change to the company's VAT profile, the VAT officer could say that you ought to have known of the changes at the time you proposed the partial exemption method.
Therefore, it is not fair and reasonable and therefore a penalty will be imposed."
Behan said, as a result, more businesses with in-house tax teams would come under pressure to take external advice to support the "reasonableness" of their calculations.
Insurance companies have been urged to review their business procedures before next year's changes to ensure that, in the short-term, they are not caught out.
Paul Bradley, partner in tax advisory services at Mazars, said: "Anyone who has restrictions on VAT, should review their present system before April.
