1. Further reductions in the Lifetime and Annual Allowances to go ahead as Finance Act 2013 is enacted.
The Finance Bill 2013 received Royal assent on 17 July and became the Finance Act 2013. The key provisions of the Act are:
- The reduction in the Annual Allowance (which is broadly the maximum pension saving that an individual can make in a year without triggering a charge to tax) from £50,000 to £40,000 from the tax year 2014/15 onwards.
- Reduction in the Lifetime Allowance (which relates to the total amount of pension savings that an individual can make within a registered pension scheme during their lifetime without triggering a tax charge) from £1.5 million to £1.25 million from the tax year 2014/5 onwards.
There will, however, be some protection for existing members by way of a fixed protection regime (Fixed Protection 2014). This will work in a similar way to the current fixed protection regime. People who earn more than £1.25 million of UK tax relief pension rights or think they may have by 5 April 2014 will be entitled to elect for a personal LTA of £1.5 million. They must, however, elect to do so by notifying HMRC by 5 April 2014. Regulations have also now been issued setting out how an individual must claim for Fixed Protection 2014 (see below).
HM Treasury have also consulted on an individual protection regime (IP 14) which, broadly, will enable people who claim it to continue benefit accrual without losing their protection. For our update on the consultation, click here
Other changes include:
- Tidying up changes to tax legislation following the abolition of contracting out on a defined contribution basis from 6 April 2012.
- Changes in relation to bridging pensions to reflect increases in State Pension age. Currently under the Finance Act 2004, where a bridging pension is provided, the pension can only be reduced, without giving rise to adverse tax consequences, if the reduction takes place no earlier than age 60 and no later than age 65. Given recent changes to the State Pension Age, amendments will be made to the Finance Act 2004 provisions so the reduction can take place any time between the age of 60 and State Pension Age. These changes are retrospective from 6 April 2013.
- A regulation-making power for HMRC to enable it to require a Qualifying Recognised Overseas Pension Scheme (QROP) to submit regular notifications to HMRC that the scheme continues to meet the qualifying requirements for a QROPs and former QROPs to continue to report payments on transfers received while they were QROPs. Further, more reasons are introduced to exclude a pension scheme from being a QROPs. These changes apply from the date of Royal assent.
- The cap on income draw-down has been raised from 100% of the expected annuity value to 120% of the expected annuity value. The change applies to both member's drawdown and dependants' drawdown.
The changes to the annual allowance and the lifetime allowance proposals will further inhibit the payment of large pension contributions into defined contribution occupational and private pension schemes. They will also impact on defined benefit and cash balance schemes, because the increase in the value of the member's pension savings during a pension input period has to be tested against the annual allowance.
As a result of a greater risk of members incurring the annual allowance charge (due to the reduction in the annual allowance), the "Scheme pays" facility whereby a member's AA tax charge exceeding £2,000 can be offset against a reduction in his accrued benefits is likely to become more popular.
The continued cutbacks to the AA and LTA may encourage more employers to establish employer financial retirement benefit schemes for employees affected.
2. VAT ruling from the ECJ could mean pension schemes can claim back VAT already paid
The European Court of Justice (ECJ) has issued a decision on the deductibility of VAT by the employer on certain services (including asset management services) provided to its defined benefit pension scheme.
The VAT challenge, against the Netherland's tax authority, was brought by a Dutch firm, PPG Holdings BV ("PPG"), which operated a defined benefit pension fund. The fund had been set up by PPG pursuant to statutory obligations. These obligations required the fund to be separate from the employer from a legal and fiscal point of view; there was no option for an employer to set up an "internal" pension arrangement, as such.
A subsidiary of the PPG Group contracted with service providers for certain service to be provided to the fund, such as administration, asset management, auditing and consultancy services. VAT became due on the payments for these services. The VAT tab was picked up by the subsidiary and not passed on to the pension fund.
In its VAT returns, PPG deducted the VAT paid on these services from its input tax on the basis that the expenditure formed part of the overheads of its taxable economic activity, and was therefore deductible under domestic legal provisions that implemented Article 17(2) of the Council Directive 77/388/EEC on the harmonisation of laws of member states relating to "turnover" taxes (such as VAT).
Article 17(2) provides that:
"In so far as the goods and services are used for the purposes of his taxable transactions, the taxable person shall be entitled to deduct from the tax which he is liable to pay: (a) value added tax due or paid in respect of goods or services supplied or to be supplied to him by another taxable person."
PPG also argued that the fund was a "special investment fund" within the meaning of Article 13B(d) of the Directive, and therefore was exempt from paying VAT on management services provided to it. The Netherlands tax authority argued that, as the services were sought for the direct benefit of the fund, it was the fund, not PPG that was a recipient of the services. PPG was therefore not entitled to deduct VAT it had paid in relation to those services. It also argued that the fund was not a "special investment fund" for the purpose of the Article 13B(d) exemption.
Under Article 17(2), a taxable person has a right to deduct VAT due in respect of services insofar as the services are used for the purposes of his taxable transactions. Citing previous ECJ decisions, the ECJ stated that for a taxable person to have the right to deduct VAT under Article 17(2), it must be the case that either:
- There exists a direct and immediate link between the particular input transaction and an output transaction; or
- Where there is no such link, where the costs of the services paid for are "part of his general costs", such costs have a "direct and immediate link with the taxable person's economic activity as a whole".
The issue therefore was whether, despite the fact that the fund set up by PGG was an entity that is legally separate from it, the existence of such a link is apparent from all the circumstances of the transaction in question. The Court found that the services in question had been acquired for the purpose of administering employee pensions and the management of the assets of the fund. PPG had set up the fund to comply with a statutory legal obligation. In these circumstances, the "exclusive reason for the acquisition of the input services lies in the taxable person's taxable activities" and therefore such a link was apparent. It went on to state that:
- "Article 17 of the Sixth Directive must be interpreted as meaning that a taxable person who has set up a pension fund in the form of a legally and fiscally separate entity, such as that at issue in the main proceedings, in order to safeguard the pension rights of his employees and former employees, is entitled to deduct the VAT he has paid on services relating to the management and operation of that fund, provided that the existence of a direct and immediate link is apparent from all the circumstances of the transactions in question."
Having answered the first question in PGG's favour, the ECJ did not consider it necessary to consider whether a defined pension fund can be classified as a "special investment fund" within the meaning of Article 13B(d). Moreover, the point was identical in substance to the decision in the Wheels Common Investment Fund Trustees and Others .In that case, the Court held that a defined benefit pension fund was not a "special investment fund" within Article 13B(d).
The decision is given in the context of certain services provided to PGG's pension fund "relating to the administration of pensions and the management of the assets of the pension fund". It is not entirely clear therefore whether all investment management services that may be provided to a pension scheme will be covered by the decision, though from the ECJ's analysis of the issues, that would appear to be the case.
The decision is in part contrary to the position taken by HMRC so far in relation to VAT. Broadly, HMRC's position has been that employers can reclaim VAT on investment administration expenses, but not on investment management services (such as advice connected with investment, brokerage charges and custodian services).
It remains to be seen if HMRC will publish guidance on the VAT position following the decision. Employers may need to consider the extent to which they need to pay VAT on investment management services going forwards. Those that have made (significant) VAT payments may wish to consider putting in claims for recovery of VAT already paid.
3. Supreme Court holds that liability under a financial support direction or a contribution notice does not have super priority as an administration expense, but ranks as a "provable debt"
In a decision that will have significant consequences for defined benefit schemes and lenders to groups of companies that have a defined benefit scheme, and the ability to restructure such groups, the Supreme Court has ruled that a Financial Support Direction or Contribution Notice issued by the Pensions Regulator against a company after it has gone into administration or liquidation will not have priority ranking as an expense of the insolvency proceedings but will instead rank as a provable debt. Herbert Smith Freehills advised the Nortel Administrators on their successful appeal in this case. For our full briefing on the decision and its implications, click here.
4. Court of Appeal holds that Lehman Scheme trustees are "directly affected" persons and that the Tribunal is not time-barred from extending FSD to other Lehman companies
The Court of Appeal has rejected an appeal by subsidiaries in the Lehman Brothers' group from a decision of the Upper Tribunal, holding that:
- The trustees of the Lehman Brothers Pension Scheme were "directly affected" persons and so could bring an appeal to the upper Tribunal. (For a person to make an appeal to the Upper Tribunal, under pensions legislation, the person has to be "directly affected" by the Regulator's actions).
- The Upper Tribunal was not bound by the two-year "look-back" period for imposing a Financial Support Direction (FSD) and so could direct the Pensions Regulator to extend the FSD already imposed on 6 of the Lehman Brother's companies to other subsidiaries in the Lehman Brother's Group (notwithstanding that the look-back period for the Regulator to impose an FSD had expired).
Following the collapse of the Lehman Brother Group in 2008, the Pensions Regulator had issued FSDs against 6 companies in the Lehman Brothers Group. It did not impose a FSD against 38 other companies in the group, the appellants in this case.
The 6 companies on whom the FSD was imposed appealed to the Upper Tribunal. The Trustees had also made a reference to the Upper Tribunal arguing the Regulator should have imposed FSDs against the other 38 target companies. In response, the target companies, the appellants, had appealed to the Upper Tribunal requesting the trustees' case to be struck out on a number of grounds, including that the trustees were not directly affected persons as their duties were purely administrative and that they had no financial interest of their own. The appellants had also argued that as the look back period for imposing an FSD had expired, the Upper Tribunal could not direct the Regulator to issue an FSD. For our bulletin on the Upper Tribunal decision, click here.
The Court of Appeal rejected the appeal.
On the issue of whether the trustees were "directly affected", it rejected new arguments raised by the appellants that the FSD was not an actual arrangement to support the scheme. The targets of the FSDs had to put forward a proposal for support which then had to be approved by the Pensions Regulator. In effect, it may take two or three more steps after an issue of an FSD for support to the scheme to become a reality and until then, there was no change in the trustees' rights and until then, they could not be said to be directly affected.
The Court of appeal emphasised that whether or not a person was "directly affected" was a factual question, which the Tribunal had to determine on a case by case basis The expression "directly affected" must also be given a contextual and purposive meaning and applying a contextual and purposive approach, the trustees were directly affected.
On the time limit issue, the Court acknowledged that the Pensions Regulator was time barred from issuing a FSD as the 2 year look back period had expired. However, the Upper Tribunal was not bound by this time limit. Citing provisions under the Pensions 2004, which deal with references to the Tribunal and the Tribunal's powers, it emphasised that the Tribunal's powers were wider than just reviewing the Regulator's actions. The Tribunal has power to remit the matter to the Regulator with such directions to give effect to its determination, which may include directions to the Regulator to substitute a different determination, order, notice or direction. The Regulator then had to act in accordance with the determination of the Tribunal including any directions given.
In this regard, the Court emphasised that the Regulator does not need to exercise its powers again and repeat the opinion forming and decision-making process set out in section 43 of the Pensions Act 2004 in relation to the issuing of FSDs. All it had to do was to comply with the directions given by the Tribunal. However, the Court was careful to emphasise that this does not mean that the section 43 conditions are of no relevance to the Tribunal. The Tribunal will look at the circumstances at the time the Determinations Panel of the Pensions Regulator made its decision and applying the whole of section 43 for that purpose, including the look back period.
On the issue of the look back period, the appellants had cited again the decision of the Upper Tribunal in Desmond and Sons that the Tribunal could not direct the Regulator to impose a contribution notice (CN) on another party as the 6-year time period for imposing a CN had expired. The Court of Appeal said that it would prefer not to comment on the reasoning in Desmonds. However, it did say that the language for the time period for CNs was much more akin to a traditional limitation period than the flexible look-back period created for FSDs by section 43.
The decision in Demsonds is being appealed by the trustees and the Pensions Regulator in the Court of Appeal in Northern Ireland (most likely on the time limit point in relation to a CN as the decision by the Upper Tribunal on the other issues raised there was largely in the Regulator and the trustees' favour ).
Generally, on the look-back period point, the Court had said that it did not wish to dwell on the issue too much as the legislation has changed since. From January 2013, the two year look-back period for FSDs ends on the issuing by the Regulator of the warning notice (and not as previously, the date of the determination by the Regulator to issue the FSD).
LB RE financing No 1 Limited and 36 others (Appellants) and trustees of the Lehman Brothers Pension Scheme and the Pensions Regulator and others (Respondents)  EWCA Civ 751
5. Court of Appeal holds Government Actuary's Department is an administrator for the purposes of the Pensions Ombudsman's jurisdiction
In R (on the application of Government Actuary's Department) v Pensions Ombudsman Civ 22 July 2013, the Government Actuary's Department (GAD) appealed to the Court of Appeal against a decision of the High Court that it was an administrator in relation to the Firefighters' Pension Scheme for the purposes of the Pensions Ombudsman's jurisdiction. The Pensions Ombudsman could therefore hear complaints from members of the Scheme in relation to GAD's alleged failures to update the commutation factors tables used by the Scheme.
The complaint centred around a provision in the Pension Schemes Act 1993 that allows the Ombudsman to hear complaints against a person who is "concerned with…the administration of the Scheme". If GAD's role in relation to the Firefighter's Scheme meant that it was "concerned with the administration", then it would fall within the Ombudsman's jurisdiction. The Court of Appeal made the following general points:
- Whether a person is an administrator is a question of fact and degree.
- The focus must be on the substance of what the person did rather than the source of their obligations.
- A person responsible for carrying out a single act of administration in connection with a scheme was unlikely to be "concerned with the administration" of the scheme, especially if the act was not central to the administration of the scheme.
GAD's role in relation to the Firefighters' Pension Scheme, which included its duty to produce and revise actuarial tables used by certain public sector pension schemes to perform benefit calculations, such as the commutation of a pension for a lump sum, was central to the operation of the scheme. This function could not be described as incidental to the running of the scheme. GAD was obliged to decide whether the tables needed updating and to update them as necessary and the Scheme structure was such that it could only function properly if GAD updated the commutation tables when necessary. The administering authorities of the Firefighters' Pension Scheme could not change the table themselves or apply different commutation rates but were obliged to use the tables provided by the Department. On that basis, GAD was "concerned with the administration of the Scheme" and therefore within the Pensions Ombudsman's jurisdiction as far as complaints from members we concerned.
The decision has implications not just for the Firefighters' Pension Scheme but also other public sector schemes where GAD provides a similar function.
The Court of Appeal was also clear in distinguishing the duties of GAD from those of actuaries retained by pension scheme managers to update commutation tables. The position was "fundamentally different" – the latter are not concerned with administration of the scheme, though they may perform functions necessary for the proper operation of the scheme.
6. HMRC confirms that mirror-image transfers between pension schemes will not give rise to the annul allowance charge for the members transferred
Last year, HMRC issued the draft Annual Allowance Charge Order. The draft Order among other things, tried to address the problem that where there is a bulk transfer and the transfer amount is not enough to support the benefits to be provided by the receiving scheme, the extent of the shortfall will be treated as an accrual and therefore count towards a member's pension input amount calculation for annual allowance purposes. This concern was based on HMRC's interpretation of s236 (5) of the Finance Act 2004 and was an interpretation that came as a surprise to many people. However, there were concerns with the drafting of the Order and the draft order was pulled.
In a recent statement, HMRC has now confirmed its views in relation to the issue as follows
- there is a bulk or block transfer (so transfers of a part of the pension fund are covered) from one registered pension scheme to another "as a result of an employer rearranging its pension schemes or as part of a business transaction"; and
- the benefits are transferred on a mirror-image basis – (including where this is expressed as a value test to ensure that some variations in benefit can be accommodated); and
- the transfer is "underfunded" (that is, the sums or assets transferred to the receiving scheme are not enough to support the benefits promised by the receiving scheme),
then such a transfer will not give rise to a pension input amount in relation to the transferred members. The changes will have retrospective effect for pension input amount calculations for 2011/12 and subsequent tax years.
HMRC will publish a draft revised Annual Allowance Order, for consultation, giving effect to its view in due course – the devil will be in the detail of the drafting. While it may be of relief to employers merging schemes on a "mirror-image" basis that such transfers will not trigger a pension input amount for annual allowance purposes, there is usually some variation on a merger in the benefits provided under the receiving scheme. The reference in HMRC's statement to including situations where the transfer "is expressed as a value test to ensure that some variations in benefit can be accommodated" suggests that there is some flexibility in HMRC's position and it is not just intending to cover situations where the transfer is on a strictly mirror image basis. However, it is not clear how far this flexibility is intended to extend.
7. Two sets of Fixed Protection Regulations issued
Regulations have been issued (coming into force from 12 August 2013) in relation to Fixed Protection.
One set deal with Fixed Protection 2012 (which relates to the reduction under the Finance Act 2011 of the Lifetime Allowance, the maximum pension saving that a member can make within a registered pension scheme without incurring a charge to tax, to £1.5m). The Regulations amend the requirements in relation to FP 2012 so that fixed protection is not lost in certain circumstances outside of a person's control - for instance, where the GMP of the member is revalued. Also, under the Finance Act 2013, the Lifetime Allowance provisions are applied to members of overseas pension schemes. The Regulations enable members of a relieved non-UK pension scheme to apply for fixed protection (in other words the Fixed Protection rules will apply to members of, and savings in, overseas pension schemes that are tested against the LTA). Members of such schemes must apply to HMRC by 5 April 2014 to take advantage of the protection.
The other set of regulations give details of Fixed Protection 2014 which will provide similar protection as Fixed Protection 2012 but in relation to the lifetime allowance from 6 April 2014. The regulations set out how an individual must claim for Fixed Protection 2014 and right of appeal should HMRC refuse the application.
Recently, HM Treasury also consulted on the individual protection regime (IP 14) which, broadly, will enable people who claim it to continue benefit accrual without losing their protection. The response to the consultation (and draft regulations in relation to IP 14 if the proposals go ahead) are awaited.
8. Regulations issued in relation to payment of partial short-service refunds
Under the Finance Act 2004, broadly, for a short-service refund lump sum (SSRL) to be paid, and therefore be an authorised payment, the lump sum must, apart from any protective rights retained by the scheme, fully extinguish a member's rights under the scheme.
Following the abolition of contracting out on a defined contribution basis from 6 April 2012, the exemption allowing protected rights to be held back ceased to apply. Schemes that had not removed provisions in their own rules relating to protected rights and were therefore obliged to hold back protected rights from the payment of a SSRL (effectively making a partial short-service refund) ran the risk of a lump sum becoming an unauthorised payment.
Regulations were issued subsequently allowing schemes that had not removed restrictions on payment of protected rights, to pay a partial short-service refund lump sum providing that this did not exceed "an amount equal to the aggregate of the member's contributions under the pension scheme". The new regulations confirm what is meant by "member contributions" in this regard. They include contributions paid by the member but also age-related rebates paid by HMRC and 'minimum payments' made by the employer to a registered pension scheme and recovered from the employee. The Regulations are retrospective in force from 6 April 2013.