As a result of recent cases relating to VAT in pension schemes, employers will need to review their arrangements carefully. This is the subject of the next in our 40-minute briefing sessions looking at current hot topics in the pensions world, to be held at our offices onWednesday, 18 June 2014, at 5pm. To book a place, please see the invitation here.
Whilst the Chancellor grabbed front page headlines with his Budget 2014 announcement abolishing the requirement for pensioners to purchase an annuity with their defined contribution pension funds, in the more rarefied world of the Court of Justice of the European Union (CJEU), important changes are being made to the VAT treatment of pension fund services. The most recent decision will open an opportunity for some to recover past overpayments of VAT but, correspondingly, HMRC may seek to recover VAT input tax recovered by employers in the past.
UK practice has been that companies providing administration and investment management services to pension funds charge VAT on their fees. By way of background, under past practice, to the extent that services related to investment management, the VAT was irrecoverable. Employers could, however, recover 30 per cent of the VAT charged which was treated as attributable to administration services. If it could be established that the services were VAT-exempt, no irrecoverable VAT would be incurred, a substantial saving for the participants in the arrangement.
CJEU decisions in past cases
In Wheels Common Investment Fund Trustees Ltd v Revenue and Customs Commissioners (Case C-424/11) (Wheels), the position was addressed as to whether administration services provided to a defined benefits scheme could fall within the exemption afforded to administrators of “special investment funds” (SIFs).
Whilst what constitutes a SIF is not explicitly defined for VAT, case law has established that funds within the UCITs Directive are classed as SIFs. UCITs covers funds which have the object of collective investment in liquid financial assets and which provide for the redemption of units out of the underlying assets of the fund. In Wheels, the CJEU held that defined benefit schemes were not comparable to UCIT funds and were not SIFs because the members did not bear the risk arising from the management of the fund.
In another Dutch case, PPG Holdings BV (Case C-26/12) (PPG), the VAT position for a defined benefits scheme was further considered and, ultimately, the opposite decision was reached. The CJEU held that VAT charged on management services to a defined benefits scheme could be deducted by the employer that had established the scheme, provided there was a direct and immediate link between the services and the employer’s economic activities as a whole.
In the third decision, ATP Pension Services A/S v Skatteministeriet (Case C-464/12), the CJEU returned to the question of whether a fund could constitute a SIF, but in the context of a defined contribution scheme. ATP provided services to an operator of occupational pension schemes. ATP’s role was to open and operate the accounts of each employee participating in a scheme, to provide advice to employees and employers in relation to the schemes, maintain a platform under which employees had access to information about their account and initiate payment out of the schemes to the employees.
Applying the principle of fiscal neutrality that businesses carrying out the same activity should be treated in the same way for VAT purposes, the CJEU held that defined contribution pension schemes, although not within UCITs, are sufficiently comparable to be in competition with UCITs funds. Accordingly, pension schemes must be treated as SIFs.
The Danish tax authorities accepted that ATP’s service in relation to payments made out of the scheme to employees were exempt but denied exemption for the services relating to the opening and operation of accounts.
The crucial difference between ATP and Wheels is that, in a defined contribution scheme, the members are at risk to the value of the underlying fund, but in a defined benefit scheme it is the employer, not the members, who bears that risk.
That is not quite the end of the story. Not every service which is provided to a pension fund involves the management of a special investment fund, and it is a question for the national courts to decide which particular service qualifies for exemption. The CJEU did, however, give a strong steer that the services provided by ATP qualified for exemption.
What does this mean for UK pension schemes?
In earlier commentary on the PPG decision, HMRC announced that it would tighten its treatment of VAT deductions on pension fund management costs. Under HMRC’s new policy, an employer must establish a direct and immediate link between the supply received and the supply made, in order to deduct VAT on the charge made on its own supplies. The policy change was effective from 3 February 2014, with a six month optional transitional period available in relation to the existing 70/30 split applying to VAT on investment management costs and those relating to VAT on general management costs. However, HMRC’s published guidance is far from clear. We understand HMRC plans to issue further guidance in Autumn 2014, the aim of which will be to clarify the implementation of these judgments.
The imminent change in VAT recoverability after the transitional period will have a substantial impact on schemes. Service providers and employers will need to review their VAT position, and advice should be taken on the possible scope for restructuring to optimise VAT recovery.
All those involved in management and administration funds need to consider their historic positions and which claims can be made to reflect the result of these decisions.