Many costs associated with defined benefit pension schemes will usually fall on the scheme employer one way or another. There are two basic heads of cost: first there are the costs associated with funding the scheme benefits which get the lion's share of employer attention.
Second there are the additional costs of managing the scheme which can be substantial. Defined benefit schemes often need a variety of advisers, some of whom are mandated by law (examples being administrators, actuaries, lawyers and investment advisers).
As with most things in life, tax increases these costs. HMRC charges VAT on the provision of goods or services. There are exceptions to this. In ATP Pension Service A/S v. Skatteministeriet (Case C-464/12) (ATP) the European Court decided that defined contribution pension schemes can fall within the exception for special investment vehicles for third party administration charges.
If VAT is payable, it can still be reclaimed by businesses for business-related goods and services. In PPG the European Court decided that VAT on pension scheme management charges can be recovered by employers, provided that there is a direct and immediate link between the services and the employer's economic activities as a whole.
How does this impact on the amount of VAT employers have on pay to their pension scheme expenses?
Before PPG, HMRC took the view that VAT on administration services could be recovered, but that VAT on investment management services could not. It also accepted that most invoices were likely to include a mix of these two elements. It allowed VAT recovery on the basis of a 70/30 split with VAT recoverable on 30 per cent of each invoice (see VAT Notice 700/17).
Following PPG, HMRC issued Revenue and Customs Brief 43 (2014) and Revenue and Customs Brief 8 (2015). These documents revoked the 70/30 rule (with transitional protection – see below) replacing it with a general ability for employers to reclaim VAT on investment management costs where:
- there is contemporaneous evidence the services are provided to the employer; and
- the employer is a party to the contract for those services and has paid for them.
So what do employers have to do?
For investment management agreements the transitional protections for the 70/30 rule expire at the end of December 2015. After this date, if a scheme's expenses do not meet the new test, the effect of the PPG ruling will be to increase the VAT payable.
It is therefore vital that defined benefit pension schemes enter new tripartite agreements which include the scheme employer as a party by this date. This is going to be more difficult than it sounds. HMRC has said that it will not accept the trustees simply adding the employer as a party to an existing agreement.
Instead the entire balance of power in the agreement will need to be shifted. As an example, the agreement will need to avoid any implication that the trustees will be on the hook to pay for the services, except where an employer defaults. Also, the employer must have certain rights under the agreement, including the ability to take legal action in the event of a breach of contract, the right to investment performance reports and the right to terminate (albeit subject to trustee consent).
Are there any wider implications?
PPG covered more than investment management agreements. HMRC has indicated that it is considering how VAT on other scheme costs (including legal costs) should be handled and will update its guidance this summer.
What about defined contribution schemes?
As a reminder, investment management services provided to defined contribution pension schemes will generally be exempt from VAT. Schemes should look to claim back any VAT that they have paid as quickly as possible because HMRC limits VAT repayment to the period of four years prior to the end of the period for which the claim is made. Any claim needs to be final and include all relevant calculations.
Who do I need to talk to if I want a bit more information on this?
Our tax and pensions experts will be very happy to talk you through what you need to do in order to benefit from this VAT exception. We will provide a further update this summer on "other costs" that HMRC is taking its time considering.