Following two recent cases in the European Court of Justice (ECJ), HMRC has published two business briefs which open the way for those involved in pension schemes to reduce the burden of VAT. Not all pension schemes fit neatly into the categories dealt with by the briefs and those hybrid schemes will need to consider their strategies carefully.
Defined Benefit Schemes
It is common practice for the costs of the administration of a pension scheme, including the cost of investment management, to be borne by the employer of the scheme’s members. Until the recent decision of the ECJ in PPG Holdings BV (PPG), HMRC practice had been to allow the employer a deduction for VAT input tax incurred (input tax) in respect of the costs of administration of a pension scheme but to disallow the input tax paid on the costs of investment management services which it regarded as something supplied to the scheme and its trustees rather than the employer. Where the employer received a single invoice for both administration and investment management services, HMRC allowed 30 per cent of the input tax charged to the employer as attributable to administration, but disallowed 70 per cent as attributable to investment management services.
Following the decision in PPG, HMRC will now accept that an employer can recover the input tax charged on both administration and investment management services, provided that the employer can show that the services were provided to it. It will be critical to this requirement that the employer can demonstrate by reference to its contracts with suppliers that it, rather than the scheme’s trustees, actually received the services. Pension schemes and employers need to review their service contracts with third parties to ensure they do not suffer an excess of irrecoverable VAT (Business Brief 43/2014). In February 2014, HMRC withdrew the 70/30 rule but then allowed a six month transitional period when the rule continued to apply. Brief 43 extends the transitional period to 31 December 2015.
Some businesses may be able to reclaim VAT which should have been allowed in the past; the procedure for making a reclaim is outlined below.
Defined Contribution Schemes
Many management services provided to special investment funds (SIFs) are not subject to VAT. In the past, HMRC limited this exemption to certain collective investment schemes, which did not include pension funds. InATP Pension Services the ECJ decided that pension funds should be classed as SIFs where the pension customers were at risk in respect of the investments and the assets of several schemes were pooled. InBusiness Brief 44/2014 HMRC confirmed that defined contribution pension schemes can be classed as SIFs. Many of the management services paid in respect of the scheme should be, and should have been, exempt from VAT.
Pension schemes should liaise with their suppliers to ensure they are paying the correct amount of VAT and make reclaims for excess VAT they may have paid in the past. This treatment will not apply to defined benefit schemes as an earlier decision of the ECJ decided such schemes were not SIFs.
Not all schemes fit easily into the types outlined by HMRC in their business briefs and these schemes will need to consider their position carefully to ensure that they are not paying more VAT than they should.
VAT reclaim procedure
Any businesses which provide management services to pension funds (the managers) that are classified as SIFs will have historically charged VAT on these services. The managers will have accounted for the VAT paid to them by the pension funds (its output tax) on their VAT returns to HMRC, and will be able to make a claim against HMRC to recover this output tax. However, it is likely that the managers will themselves have benefited to some extent from being able to recover VAT on supplies which they have received, which they would not have been able to recover in full if their supplies to the pension funds had been exempt.
As a matter of law, the managers can make a claim against HMRC for repayment of VAT which has been overpaid looking back four years from the date of the claim (subject to the principle of unjust enrichment).
Similarly, employers operating defined benefit schemes may not have been receiving credit for VAT they have paid in respect of investment management services. HMRC has invited managers and employers to make these claims, together with the necessary supporting evidence.
Under HMRC’s “reimbursement scheme”, managers can obtain a refund of VAT that they accounted for in error, and avoid being unjustly enriched, by undertaking to pass any refund plus interest back to the customer who bore the burden of paying the VAT mistakenly.
Any pension fund which is a SIF and which has incurred VAT on its management service costs may have a contractual claim against the managers for any losses arising from the incorrect charging of VAT. Of course, some pension funds themselves may have been able to recover some of this VAT where they make taxable supplies, and any “loss” will be restricted to the proportion of the VAT which the pension funds were not able to recover. Where a manager has made a claim under the reimbursement scheme, pension funds should be able to recover an amount representing the irrecoverable VAT that they suffered on the management services provided to them over the last four years, from their managers.
The extended deadline for the 70/30 rule transitional period may sound generous but complying with HMRC’s new approach may take some time once the relevant contracts are reviewed and renegotiated where required.
As far as hybrid schemes are concerned, the application of the new criteria outlined in HMRC’s publications may prove more complex than it first appears and options for these schemes should be considered as soon as possible.
For defined benefit schemes, it is good news that HMRC has now clarified its approach to VAT recovery in respect of administration costs and investment management services. However, affected scheme sponsors should take early advice in order to ensure that any overpaid VAT is recovered. For defined contribution schemes it will be important to ensure that the relevant management services are treated as VAT exempt in future and that any overpaid VAT is recovered.