Insurance companies outsourcing their back office operations face a large tax bill if the European Court of Justice confirms a preliminary opinion issued this week. Dominic Coyle reports.

The court's advocate general has stated that firms insurers outsourcing back office operations such as claims processing should pay VAT. At present, Irish law states that no VAT is payable in such situations.

KPMG VAT partner Mr Terry O'Neill said that, if confirmed, the ruling would mean the cost benefits for insurance companies of outsourcing would be outweighed by the 21 per cent VAT charge.

"This could be very significant for Irish insurance companies," agreed Mr Jarlath O'Keeffe at Ernst & Young.

It may be several months yet before the court rules one way or the other on the case, which emerged following a dispute between the Dutch Ministry of Finance and Accenture, which was undertaking back office functions on an outsourced basis for a Dutch insurer Universal Life.

Two Irish companies are seen as particularly vulnerable to an adverse ruling - Irish Progressive Services International, which is part of Irish Life & Permanent, and Friends First International. Both are third party administrators undertaking back office functions for European life companies with operations in the IFSC.

While the business is not critical to either Friends First or Irish Life, industry sources indicated it was notably profitable.

A spokesman for Friends First said an adverse ruling would "affect the financial model underlying the argument for outsourcing", and it was unlikely to lead to the loss of existing business. While the court usually confirms an advocate general's opinion, industry sources were upbeat about a favourable outcome on the VAT issue.