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Sun 8 Mar 2020 10:36 AM

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Changing operating models in Financial Services - why technology, data and disruption will change tax forever

The reality now dawning on tax authorities around the world is that the tax system - designed more than 100 years ago for trade and commerce that consisted largely of manufactured items - may not be the most appropriate way of taxing today's global and digital businesses.

Changing operating models in Financial Services - why technology, data and disruption will change tax forever

Peter Maybrey, PwC Middle East Financial Services Tax Leader

Disruption has become a fact of life for financial services companies in the Middle East and around the world, whether in banking, insurance or asset and wealth management. In a poll conducted at a global PwC tax forum, 88 percent of delegates said they expected technology to change the operating model of their businesses either moderately or significantly in the years ahead, demonstrating that most are under no illusions about the transformation to come. But as the industry’s value proposition begins to shift, what will that mean for the way in which value is taxed?

The reality now dawning on tax authorities around the world is that the tax system - designed more than 100 years ago for trade and commerce that consisted largely of manufactured items - may not be the most appropriate way of taxing today’s global and digital businesses. The data revolution now sweeping through the financial services industry provides a case study in why this is true; not least, the arm’s length principle - the mainstay of transfer pricing regimes to date - that just does not work when the most valuable asset that corporations have is information.

Substantial recent activity being undertaken by investors, including from the Middle East and sovereign wealth funds, is driving technology transformation both inside and outside the region.  The impact of technology on FS operating models, and in turn, the impact on taxation of those models, is therefore of particular interest in the region. Additionally, some jurisdictions in the region have no corporate income tax. Change to the status quo on international tax with extra territorial impact, such as the global minimum tax proposed under OECD BEPS Pillar 2, is likely to mean financial institutions paying more tax overall.

A new value model for financial services

Globally, this challenge is only set to become more pressing, whichever segment of the market you look at:

  • In banking, fintechs and other new entrants to the industry are reshaping the marketplace, capitalising on regulatory change such as open banking. Their business model is centred on using technology, data and analytical tools to offer a much more bespoke and personalised range of products and services, in a cheaper, quicker and more tech enabled way. Fintechs are seeking to deliver a customer experience for financial services and products that more closely resembles what consumers have come to expect from the digital technology giants such as Amazon and Netflix.

  • In insurance, the disruptive trends include the increasing disintermediation of the sector, with technology offering insurtechs and other competitors the opportunity to shorten the value chain and capture more of its profit; data analytics tools are enabling insurers to move away from traditional underwriting, offering more personalised insurance products.

  • In asset and wealth management, the growth of robo-advisers, powered by artificial intelligence that learns from both market and consumer data, is just one example of how the sector is changing fundamentally.

All of these changes – and more – raise pressing questions for companies and policymakers alike.

In banking, for example, tax professionals are trying to understand what and where value is truly being generated – for example, is it in the country where users are located and where they hand over their data, or is it the location of the data storage and processing activities? Similarly, trying to determine the value and nature of service provides VAT challenges - is the service being provided a technology service or a financial service, and is this a taxable supply, an exempt supply or partially exempt?

Similarly, in insurance, the nature of intellectual property is now changing fundamentally, as insurers apply technology to underwriting and claims processes in new ways. That moves the dial on intangibles. Equally, insurers’ tax profile will be impacted by the increased upfront capital spending that new technology, such as automation in call centres requires and the reduced operational cost of smaller workforces.

In asset and wealth management, the same question marks apply. If a business stands or fails on its ability to turn market data into insight of value to its customers, where will its tax exposures lie?

Change on its way

No wonder policymakers and tax authorities have begun to rethink their approach to taxing financial services. Around the world, new digital services taxes are being proposed. At first instance, these may not initially capture many financial services businesses within their net – but this may change in the future, as the lines between industries are blurred by digital technologies.

Split payment systems for VAT are also likely to proliferate as tax authorities seek to prevent erosion of the tax base through non-compliant cross-border online sales. Again, it is easy to see how the current focus on online retail could very quickly cross over into financial services.

Elsewhere, the OECD has already begun to retreat from the arm’s length principle as it thinks harder about how to apply the principles of its approach to base erosion profit sharing (BEPS) to financial services in the digital world. That trend looks set to continue.

Financial services groups must be ready to respond accordingly to these evolving business and operating models – to participate in the debate and to be prepared to comply. Digitalisation is already transforming financial services; tax must not be left behind.

* Peter Maybrey is PwC's Middle East Financial Services Tax Leader

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