Pension schemes in the UK cannot normally recover the VAT paid on their expenses as they don’t make VATable supplies. Sponsoring employers who make taxable supplies and are registered for VAT do often arrange to reclaim that VAT, but the rules are changing.
However as the issues seems to get ever more tangled, HMRC have just extended the transitional period for resolving this for a further 12 months to 31 December 2016. During this period schemes and employers can continue dealing with VAT as they have always done and get the same treatment from HMRC.
In July 2013, the European Court of Justice reached a decision (in PPG Holdings BV) about the extent to which an employer could recover VAT on the expenses of running a pension fund. The pension fund in that case was a Dutch one which, like a UK occupational pension scheme, is set up as a legal entity legally and fiscally separate from the employer.
The Court held that an employer who has set up a separate pension fund is entitled to deduct VAT he has paid on services relating to the management and operation of the fund, provided there is an immediate and direct link to the employer’s activities which is apparent from all the circumstances.
This case was initially welcomed by the UK pension industry as it seemed it would make it easier to recover VAT on pension scheme costs. However, HMRC has taken a restrictive view of the ruling, as a result of which it will be harder for many employers to recover VAT in future.
Prior to the European Court decision, HMRC distinguished between day to day administration costs and the costs of managing the investment of scheme assets. HMRC allowed employers to deduct the VAT incurred in relation to the administration costs on the basis that they were overheads of the employer and had a direct and immediate link to the employer’s business activities.
In practice, HMRC was satisfied where the invoice was either addressed to the employer or marked as being clearly payable by the employer. HMRC viewed investment management costs as purely costs of the scheme, not overheads of the employer, and so VAT on the investment management costs could never be recovered.
Where a single invoice was issued covering both administration and the management of investments, HMRC allowed the employer to treat 30% of the VAT as relating to the administration and therefore recoverable. The 70% balance would be treated as related to investment management and not recoverable.
HMRC has revised its policy and will no longer distinguish between administration and investment costs. It will require a much higher test as to whether the employer is the recipient of the relevant services.
There must be strong evidence that the services are provided to the employer and, in particular, the employer must be a party to the contract for the services, as well as having paid for the costs of them.
WHY IS THIS A PROBLEM?
The Pensions Act 1995 requires some services to be provided to the trustees and specifies that the trustees must be the party to the agreement with the service provider. For the supplier to enter into a contract with the employer would breach those requirements.
HMRC has accepted that a tri-partite agreement structure may well be effective for VAT purposes provided that the agreement recognises that the services are provided to the employer (even if the supplier is appointed by or on behalf of the trustees), the employer is primarily responsible for payment of the charges and the employer would be able to sue the supplier.
This still presents some really tricky problems, in particular in areas where advice provided by the supplier is potentially in conflict with the employer, such as the provision of actuarial advice, independent financial advice on the strength of the employer covenant, and legal advice to the trustees.
Tri-partite agreements in these circumstances will be extremely difficult to put in place. HMRC recognised this in issuing a guidance brief in March 2015 on tri-partite agreements which is principally concerned with investment management agreements.
The most recent brief in October 2015 suggest that the tripartite structure could also prevent the employer from getting a corporation tax deduction on the expenses, and considers other possible options, including the trustee registering for VAT and agreeing to provide VATable services to the employer, and a corporate trustee being included in the same VAT group as at the employer.
Transitional period and further guidance
The previous rules, including the 30/70 per cent split for mixed invoices, will continue on a transitional basis to allow employers and trustees to make changes to the contractual arrangements where required.
This has just been extended to 31 December 2016, (from 31 December 2015) by the most recent HMRC brief, which also promises further guidance "later this year".
WHAT DOES THIS MEAN FOR YOU?
To the extent that the employer is currently paying for, and recovering, VAT on any of the professional services supplied to the trustees of the pension scheme, whether taking advantage of the 30/70 concession or otherwise, these arrangements can continue until 31 December 2016 but must then cease unless they meet the new tests.
Claims by the employer to recover VAT on these expenses after that date will only be acceptable if the employer has entered into specific service contracts which meet HMRC’s requirements.
Employers may have to incur material costs in re-negotiating and revising the arrangements with the pension scheme’s suppliers (unless the supplier is willing to bear those costs) and, in some cases, it may not be worth doing if the amounts at stake are not sufficiently great.
Various bodies within the pensions industry are seeking to design a different solution which will satisfy HMRC, but so far with no success.
If the VAT recovery is important to you and/or your scheme, then you should get in touch with your normal pension contact and we can advise you in more detail as to how you might proceed. Luckily it seems we still have a bit longer to find a workable structure.