The Government has been dealt its second blow by Europe in as many days, following the ruling by the European Court of Justice that insurance companies will have to pay VAT on outsourced back office services.

The decision of the court will add 21 per cent to the cost of such arrangements, raising doubts about the viability of outsourcing for the industry. It comes a day after the Government withdrew plans to provide grant support of €170 million to US chip giant Intel's Irish expansion in the face of EU opposition.

The European Court of Justice yesterday backed an earlier opinion by the Advocate General that the outsourcing of back office operations to specialist providers did not qualify for a VAT exemption as insurance-related services performed by brokers or agents.

The case centred on a dispute between Accenture and the Dutch tax authorities. Accenture argued that it was acting as an insurance agent but this was rejected by the European court.

Two Irish companies are seen as particularly vulnerable to the ruling. Irish Progressive Services International, a part of Irish Life & Permanent, and Friends First International. Both are third party administrators for European life companies with operations in Dublin's IFSC, notably Italian insurers.

The business is seen as very profitable for both groups although it is not seen as critical for either. Friends First has acknowledged that the adverse ruling will affect the financial model underlying the argument for outsourcing.

Industry sources had been confident that the full court would not support the Advocate General's opinion on the issue.

KPMG tax partner Terry O'Neill said the decision was worrying and had potential knock-on effects on other areas of the financial services industry. "A key driver of growth of financial services in Ireland has been the ability to have certainty on tax issues," he said. "Cases like this reduce that level of certainty."