Comment: After people and infrastructure, VAT is the highest cost facing the financial services sector. Together with the complexity of EU VAT rules for financial services and their inconsistent application across Europe, this is causing real commercial difficulties for industry.

Earlier this week, the European Commission published a consultation paper aimed at modernising VAT legislation for the sector. It is almost 30 years since financial services VAT legislation was last updated.

Since that time, the way in which business is conducted has changed beyond all recognition. Increased outsourcing of activities and the continuous development of new products have highlighted the inability of current legislation and practice to deal with the ever evolving financial services sector.

It is hoped that the consultation process will address and ultimately resolve many of the issues currently faced. The importance of the review and the Republic's participation in the consultation process should not be underestimated.

While Irish governments have successfully fought for control over national fiscal policy in EU tax legislation, there is a quiet, yet inevitable, ceding of control over VAT.

It is becoming increasingly clear that it is the policymakers in Brussels and the European Court of Justice in Luxembourg that are setting the rules. Therefore, unless Irish business actively participates in the consultation process, we could well find that legislation that may not be in the best interests of Irish industry is imposed on us for the next 10-15 years.

What are the aims of the review? Very broadly, the commission aims to reduce the levels of irrecoverable VAT being incurred by the industry, to modernise VAT exemptions for changes in business practice and to ensure that the EU is a more competitive location for financial services.

A number of alternatives aimed at reducing VAT costs have been raised in the consultation paper, including applying a zero VAT rate in business-to-business (B2B) transactions and the application of a flat VAT recovery rate similar to Australia.

It would be extremely foolish to predict which proposal or combination of proposals the commission could opt for, but clearly any solution must be pragmatic and capable of being implemented in a cost effective manner.

Again, while the application of, say, a zero VAT rate in B2B transactions might initially appear attractive, the question of what the actual monetary benefit is for Irish operators must be assessed.

Clearly, any move to a system radically different from that at the moment would also require a significant investment in IT enhancements, revisions of business plans etc.

The commission is seeking responses to its consultation paper and is asking industry to identify other areas of concern or options for change by June 9th, 2006.

The next step will be a public conference on May 11th and the commission will also meet member states later that month to develop the issues. The commission then intends to publish a report detailing their findings with the ultimate aim of having revised draft legislation published by the end of autumn.

Therefore, time is of the essence if Irish operators are to have constructive input into the process and to manage any potential impact on their business.

Given the strategic importance of the financial services industry to the Irish economy, the need to participate in the consultation process should not be underestimated. It is critical that we retain our competitive position in areas such as fund management, asset finance and securitisation. Clearly no single solution will fit all industry sectors and all operators.

Over the years, Irish industry has sought to obtain a fair and balanced approach from Revenue and, for the most part, this has been achieved. The danger now from an Irish perspective is that the commission will approach the review from a macro EU level, imposing a solution that is best for the EU as a whole. It is important that any changes arising from the consultation actually build on the efforts of Irish industry and Revenue to date.

To ensure that Irish operators maximise the benefits and minimise the risks inherent in the consultation, it is incumbent on them to critically assess the various proposals and quantify the actual monetary impact on their business. Armed with this knowledge, they will be better positioned to participate in and shape the process. It is important that we begin this process immediately.

The issue is a particularly complex one given the potential monies in play and political sensitivities.

However, being an integral part of the consultation process is the only way we can protect our own position and ensure that any solution is acceptable to Ireland Inc as a whole.

Keith Loughman is a director in KPMG Dublin. He is global chairman of KPMG's financial services VAT network.