- Funded pension schemes
- The rollercoaster of HMRC policy
- VAT liability of investment management services
With the new legislation on workplace pensions, all employers must automatically enrol their employees into a work place pension scheme if they:
- Are not already in one
- Are aged between 22 and State Pension age
- Earn more than £10,000 a year
- Work in the UK
Apart from enrolment, employers are of course obliged to make contributions and are likely to incur various pension scheme management costs.
This new requirement makes issues relating to VAT recovery of pension scheme expenses relevant to a vast group of employers, and with recent HMRC policy changes in this area, it is something that businesses must be careful about as the new terrain has not been settled yet.
Funded pension schemes
This article is about funded pension schemes i.e. those in which the employer and employees’ contributions are vested in separate trustees. They are normally separate and distinct from the employer’s business. It is not about schemes where an employer may provide pensions to his employees by means of:
- An insurance based scheme whereby retirement benefits are secured through an insurance policy
- An ‘unfunded’ scheme where no specific funds are set aside to pay pensions; or
- A scheme where the employer makes provision for the payment of pensions by a segregated reserve fund in the balance sheet, represented by specific assets
In the above cases, as per HMRC policy, the employer has always been able to recover any input tax subject to normal rules, such as any necessary partial exemption restriction.
The rollercoaster of HMRC policy
Historically, as per VAT Notice 700/17, HMRC made a distinction between the setting up and day-today administration/management of occupational pension funds and the management of investment activities of the fund.
Where employers received VAT invoices in their own name, even if these invoices were paid by the pension trustees rather than the employer, they have been able to recover the input VAT relating to the general management and administration of pension schemes such as:
- Management of the scheme including collecting and distributing contributions
- Accountancy and audit services
- Consultancy advice on the scheme and changes required
- Actuarial valuations
- Certain legal services
However, HMRC’s position was that VAT in relation to the management of investment activities of the pension fund was not recoverable by employers as there is no direct and immediate link between these costs and the activities of the employer, since investment advice relates solely to the pension fund itself. Thus, in theory, any VAT incurred on investment management was deductible only by the pension scheme trustees. In practice, many funds were not even registered or registrable for VAT purposes, so the associated VAT was often not recoverable.
Where both administration and investment management of the fund were invoiced together by providers without any itemisation, HMRC agreed that an element of VAT incurred on fund administration charges was recoverable by the employer, regardless of whether the fund or the employer engaged with or paid the fund manager. In practice this concession was implemented by the 70/30 split scheme, with 30% of the VAT incurred deemed to be in relation to the administration of the fund and potentially recoverable by the employer as input tax. The remaining 70% of VAT incurred was considered as relating to investment advice and therefore generally not recoverable as input tax.
The landmark decision in PPG Holdings BV
The Court of Justice of the European Union (“ECJ”) made its landmark decision in the PPG Holdings BV C-26/12 case (“PPG”) in July 2013 confirming that PPG, as the sponsoring employer, was entitled to recover all VAT incurred in relation to their defined benefit pension scheme, which was a legally separate entity and the costs were not recharged to the fund. In reaching this decision, the court noted the following:
The deduction system for VAT is intended to relieve the operator entirely of the burden of VAT paid or payable in relation to all his economic activities, thereby ensuring complete neutrality of a taxation of all those activities.
The ECJ held that as long as the pension-related services in question formed part of PPG’s general costs then they would be components of the price of PPG’s products. In such circumstances a direct and immediate link is established as the sole reason for PPG purchasing the services was to carry out its general taxable activities.
The ECJ also noted that the sole reason for PPG setting up the fund was to comply with obligations imposed upon it as an employer. The legal and fiscal separation of the pension fund was a requirement of the Dutch law, not choice.
HMRC has taken over half a year to reconsider its policy after the PPG judgement and finally, in February 2014 Revenue and Customs Brief 6 (2014): deduction of VAT on pension fund management costs was published, revoking the previous HMRC policy with immediate effect. There was a transitional period until August 2014 to allow businesses to adapt to the changes.
HMRC reconsidered its position as to what constitutes a direct and immediate link to the supplies of the employer. A direct and immediate link is generally required to reclaim VAT as input tax and the basis of the PPG decision is that there is a direct and immediate link between the supplies of the employer and the input tax incurred on supplies to the pension fund of the businesses employees.
HMRC accordingly broadened the cases where an employer should be able to reclaim VAT on costs incurred by a pension fund and outlined circumstances where the revised approach will not apply. For instance, where a cost has a direct and immediate link to specific suppliers or groups of supplies then it cannot also be part of its general costs e.g. the costs of managing a property within a pension fund will have a direct and immediate link to the rental income derived from the property so any relating VAT cannot be treated as residual input tax of the employer. However, where the services received go further than the management of the investments and perhaps include pension administration services, they may be general costs. Therefore, provided that the supply is received by the employer, the VAT incurred would potentially be deductible. Back in February 2014 HMRC required that a consideration of whether the employer has commission and paid for the service is given to determine if the employer received the supplies.
HMRC also required that consideration was given to whether the employer had commissioned and paid for the service to determine if the employer received the supplies.
However, the implementation of the new HMRC policy was not so straightforward for the pension schemes and industry representatives started extensive discussions with HMRC which in May 2014 led to the issuing of Revenue and Customs Brief 22 (2014): judgement on deduction of VAT on pension fund management costs. Effectively, HMRC announced that businesses could continue to use the transitional arrangements even longer than originally prescribed, whilst further guidance was expected in the autumn.
Eventually, Revenue and Customs Brief 43 (2014): VAT on pension fund management costs was published in November 2014. One of the main differences from the initial Brief is that there is no longer reference to the requirement for the employer to commission the services. HMRC also added that, in line with the PPG judgement, they accept there are no grounds to differentiate between administration and management costs but a business would require a valid VAT invoice to potentially recover the VAT.
The brief explicitly states that HMRC will not accept that the VAT is deductible unless there is contemporaneous evidence that the employer:
- receives the service, and in particular
- is a party to the contract; and
- has paid for the services.
Where HMRC accept that an employer has received the supplies, and charges them on to the pension fund, this will be a taxable supply and the pension fund will be subject to the usual VAT recovery rules. In this instance, where the fund is not registered it will not be able to recover the VAT, or where the fund is registered there could be relatively low rate of VAT recovery.
HMRC has extended the transition period to 31 December 2015 to allow businesses time to adapt to HMRC’s change in policy. Following the closure of the transitional window, HMRC has confirmed that the 30/70 administrative simplification will be withdrawn.
While HMRC’s new policy appears to be fairly clear, economic reality and the actual agreements involving the pension trustees and the sponsoring employer should be considered. It yet remains to be seen how pension trustees could adopt this new policy to ensure that their independence is not compromised. VAT grouping of incorporated pension funds with the employer company may also seem like a viable option eliminating the VAT issue. We may hear from HMRC on this topic again soon...
VAT liability of investment management services
Issues relating to VAT recoverability arise if a positive rate of VAT is applicable on the supply. However, if no VAT is charged by the supplier then the VAT issues on the purchaser side go away.
PPG have asked ECJ if the management of defined benefit (“DB”) fund should be VAT exempt as relating to a special investment fund. ECJ did not need to answer this question as this point had already been addressed in the case of Wheels Common Investment Fund Trustees - fund management services provided to DB schemes are subject to VAT.
However, in a subsequent ECJ case of a Danish pension provider ATP Pension Service A/S a similar argument was raised regarding a defined contribution (“DC”) scheme. The court held that since, in a DC scheme the investment risk is borne by the employees, the fund constitutes a special investment fund. Such management fees are accordingly exempt from VAT.
In November 2014, HMRC issued Business Brief 44 (2014): VAT treatment of pension fund management services in relation to DC schemes. HMRC now accepted that funds which meet the following characteristics should be, and always should have been, special investment funds (“SIFs”) exempt from VAT:
- Solely funded (whether directly or indirectly) by persons to whom the retirement benefit is to be paid.
- The pension customers bear the investment risk.
- The fund contains the pooled contributions of several pension customers.
- The risk borne by the pension customers is spread over a range of securities.
Moreover, where fund management and administration services that are integral to the operation of a pension fund are supplied, these will qualify for VAT exemption. This includes the service of administering the pension accounts as well as investment management and fund administration services.
Therefore, considerable VAT savings can now be achieved by DC schemes both prospectively and retrospectively.
By Joanna Davies
Joanna has been working in VAT since 2002 mainly in in-house roles and qualified as ATT in 2005. She currently also volunteers for the Association’s Business Development Steering Group.