1. Budget 2014: Government overhauls tax rules to give greater flexibility to people over accessing their defined contribution pensions
In the Budget delivered on the 19 March, Chancellor George Osborne announced measures overhauling the tax regime in relation to defined contribution (DC) pension arrangements. The measures are intended to give greater flexibility to people to access their DC pension pots. The tax rules allowing individuals to take some or up to all of their DC pot as a lump sum will be relaxed, as will the rules relating to ‘income drawdown’ (a facility that allows individuals to draw down income from their money purchase pension pots). Although the overwhelming emphasis of the Budget is on DC benefits, some of the changes proposed apply to, or will invariably have an impact on, defined benefits. For our update on the Budget and its implications, click here.
2. Finance Bill 2014: the pensions clauses
Following the Budget the Finance Bill 2014 was published. The Bill contains clauses in relation to the pensions-related proposals announced in the Budget that were due to take effect from 27 March 2014. These are principally:
- An increase in the maximum income that a person may draw down under Capped Draw-down from 120% to 150% of an equivalent annuity.
- Reducing the minimum income threshold for Flexible Draw-down from £20,000 to £12,000.
(These changes will apply for draw-down pension years starting on or after 27 March 2014)
- Increase in the trivial commutation limits in relation to total pension savings of an individual from £18,000 to £30,000 - the new limits will apply to all commutation periods starting on or after 27 March 2014.
- Increase in the limits in relation to a "small pension pot" which can be taken as a lump sum from a single pension arrangement from £2,000 to £10,000 and the number of pension pots that can be taken under these rules from two to three – this change applies to all payments made on or after 27 March 2014.
These measures were given temporary statutory effect in the Budget resolutions passed on 25 March, until the Finance Bill is enacted in the Summer.
The Bill also contains provisions giving extensive powers to HMRC from 20 March to combat pension liberation with greater powers in relation to the registration and de-registration of pension schemes (these powers were also given temporary legal effect under the Budget resolutions) and clauses in relation to the Individual Protection regime.
There were some concerns as to whether the new trivial commutation limits would apply in relation to defined benefits, given that the overwhelming focus of the Budget was on easing access to DC pots. However, from the draft clauses, it would appear that the new limits would apply in relation to DB benefits too, even where a member only has DB benefits and no DC pots.
3. ECJ rules that Occupational DC schemes do not have to pay VAT on administration expenses
The Court of Justice of the European Union has ruled that an occupational defined contribution scheme may fall within the exemption under Article 13(B)(d)(6) of the Sixth VAT Directive. Article 13(B)(d)(6) requires member states to put in place measures to exempt from the payment of VAT “the management of special investment funds as defined by Member States”. As part of the measures to implement the Directive, Danish law provided that certain goods and services including the “management of special investment funds” were to be exempt from VAT.
The case concerned certain administrative services performed by ATP, a Danish company, in relation to its occupational pension fund customers. ATP contended that it did not have to pay VAT on fees received from pension funds for the services it provided to them as these were exempt under the Directive.
The Court held that the essential characteristics of a 'special investment fund' are that:
- the assets of several beneficiaries must be pooled;
- the fund must enable the risk borne by the beneficiaries to be spread over a range of securities.
Looking at the Danish pension funds in question, the Court held that these funds had such features. The Court distinguished these funds from the arrangement that was in question in the case of Wheels Investment Fund Trustees and Others v Commissioners for Her Majesty’s Revenue & Customs - being a defined benefit fund, the members of the scheme in that case did not bear the risk arising from the management of the fund in which the scheme’s assets were pooled and the pension was defined in advance on the basis of the length of service with the employer and the amount of salary.
The second question the Court asked was whether services that were being provided by ATP to these pension funds constituted “management” of the special investment funds. Absent any meaning given to the term in the Sixth Directive, the Court stated that in the past, it had been held that certain services such as “computing the amount of income and the price of units or shares, the valuation of assets, accounting, the preparation of statements for distribution of income, the provision of information and documentation for periodic accounts and for tax, statistical and Vat returns, and the preparation of income forecasts” are covered by the concept of “management” of a special investment fund for the purposes of Article 13B(d)(6).
The Court also held that the term covered services by means of which an undertaking establishes the rights of pension customers vis-à-vis pension funds, for opening accounts in the pension scheme system and crediting such accounts with contributions paid – the parties in the case had contested whether these fell within the concept of “management”. Accounting services and account information services were also covered.
This is another in a line of a number of recent cases concerning the payment of VAT.
In the Wheels case referred to in the current case, the Court held that the pension scheme in question, a defined benefit scheme, did not fall within the special investment fund exemption – for our update on that decision, click here.
In the more recent case of PPG Holdings, the Court held that taxable persons, including employers, who established a legally and physically separate pension fund may in certain circumstances deduct the VAT paid on services relating to the management and operation of the fund. Following the decision, HMRC has revised its policy in relation to the recoverability of VAT on services provided in relation to pension funds. For our update on the revised policy, click here.
ATP Pension Service A/S v Skatteministeriet  EUECJ C-464/12
4. DWP proposes cap on charges of 0.75% on default funds in DC auto-enrolment schemes
The DWP has issued a Command Paper published in March 2014, which among other things sets out its response to its consultation on caps on charges in auto-enrolment DC schemes. The paper proposes that from April 2015, a flat charge cap of 0.75% will be imposed on default funds in DC qualifying schemes. The cap will apply to all management charges, but will initially exclude "transaction costs". The Government will in 2017 review whether some or all transaction costs should be included in the default fund charge cap and whether the cap should be lowered further.
What is and what is not covered by the cap
The default fund charge cap will encompass all member-borne deductions (MBD) paid to the pension provider or another third party, excluding transaction costs. Member-borne deductions will include everything taken as a flat fee or a percentage from members’ funds under management, contributions, or investment returns, specifically related to the administration of assets (both general scheme administration and investment administration). MBDs will be used in place of the current Annual Management Charge measure.
The MBD measure relates to the cost of administration (general scheme and investment administration) which can be identified in advance and relates to services such as administering the pension scheme, keeping records, complying with regulations, communicating with members and designing the investment strategy. Transaction costs, on the other hand, are the variable trading costs a scheme incurs when buying, holding and selling underlying investments. These costs cannot be predicted at the beginning of a reporting period as they are dependent on the level and nature of trading undertaken by a scheme, which in turn is influenced by market conditions. Transaction costs include:
- Brokerage commission and fees.
- Soft commission services included in brokerage fees, e.g. research costs.
- Transaction taxes, e.g. stamp duty and non-reclaimable withholding taxes on dividends.
- Other charges embedded in the transaction price, e.g. payments incurred through financial derivative instruments.
- Entry fees, other initial charges and exit fees for investment in underlying funds.
- Deductions of expenses or fees from profits such that they are not shared equally with members, e.g. in relation to activities such as stocklending, interest income and foreign currency exchange.
The Paper states that certain services should be excluded from default fund charging i.e. 'add-on services', such as wider insurance features, which should not be borne by members without the members opting-in. Members should only be defaulted into paying for those services without which the pension cannot function and from which every member benefits. Services which could be viewed as optional should be marketed as 'add-on' features.
Guidance to Members
The Paper also refers to the announcement in the Budget that a duty will be imposed on pension providers and trust-based schemes that they must offer to each of their members a 'guidance guarantee' at the point of retirement - the Paper states that members should not be charged for guidance delivered under these requirements.
The Paper also sets out the Government's view that commission is an inappropriate charge in the automatic enrolment environment, as members may be defaulted into paying for a service they may not use and are not aware of. A ban on member-borne commissions will be introduced after the proposed default fund charge cap as follows:
- From April 2015: where commission is in place, this should not take any member’s charges above 0.75% (the level of the default fund charge cap).
- From April 2016: commission charges must be removed from all qualifying schemes altogether.
Members can, however, voluntarily agree to pay for any optional services provided.
On 14 September 2013, regulations came into force that banned consultancy charges in automatic enrolment schemes. No new schemes can be set up with built-in consultancy charges or commission, but the nature of the ban on consultancy charges means that it is still possible for employees to be automatically enrolled into existing qualifying schemes containing these charges. The Paper confirms that the ban will be extended to cover all qualifying schemes from April 2015.
Minimum quality standards
The Paper also gives details of a minimum quality standard scheme in workplace pensions to ensure that those running schemes consider the key components of scheme quality keeping members’ interests as their priority. The quality standards will consider the different strengths and weaknesses of trust and contract-based structures. There will be requirements from April 2015 for providers of contract-based schemes to operate Independent Governance Committees (IGCs) to assess the value for money delivered and report on how the quality standards are met. There will also be requirements from April 2015 for trustees to consider and report against the quality standards with new measures to strengthen the independence of governance in mastertrust arrangements.
Disclosure and transparency
The Paper also confirms the proposed rules and timetable on transparency in DC schemes (originally discussed in our February bulletin). From April 2015, duties on enhanced transparency will come with the introduction of IGCs and strengthened trustee boards. Following this initial obligation, the DWP proposes that future regulations will require:
- Providers of workplace DC schemes to disclose information on all charges and costs to trustees and IGCs.
- Providers and trustees to provide information about charges and costs to employers before the employer makes a choice of scheme and on an annual basis thereafter.
- Providers and trustees would be required to provide information about charges to new and prospective scheme members, and headline charges and costs annually as part of the annual benefit statement.
The DWP is also seeking views on whether these transparency requirements should be extended to DB schemes to enable employers to further scrutinise the costs they are paying.
The changes proposed are extensive. The consultation includes proposals as to the detail of the secondary legislation that may be needed to give effect to the proposals and runs until 15 May 2014.
The Pensions Regulator 5. Determination Panel refuses to order a scheme surplus to be refunded to the employer
The Determinations Panel has issued a determination refusing to exercise its statutory power to enable a surplus in a defined benefit scheme to be refunded to the employer.
The Pensions Regulator has a statutory power (under the Pensions Act 1995) to modify a registered pension scheme which is being wound up to enable surplus assets, after the ‘liabilities’ have been fully discharged, to be distributed to the employer (subject to certain conditions being met).
The defined benefit scheme in question had an estimated £540,000 surplus (after satisfying members’ benefit entitlements under the scheme and paying off winding-up costs). The scheme employer and the trustees proposed to apply a third of this surplus to augmenting members’ benefits and two-thirds to satisfying the employer’s obligations to make contributions to its DC scheme in respect of former members of the Scheme who were now members of the DC scheme. As there was no express power under the scheme rules for a surplus to be distributed to the employer, the Trustees made an application to the Pensions Regulator to exercise its statutory power to refund two-thirds of the surplus to the employer, to be ring fenced from the employer’s assets in a separate bank account and used to meet the employers liability to the DC arrangement for former Scheme members.
The Panel’s determination
The Panel refused the application. A rule of the scheme (Rule 19) required that any surplus “shall be used to increase the benefits conferred upon the Members…in such a manner as the Trustee may decide.”
The Panel considered what was meant by “liabilities” and decided, that as a matter of ordinary English and legal authority, the word “liability” meant “under an obligation at law”. The Panel found that whilst it was in the Trustee’s discretion how it distributed the surplus, the Trustee was obliged to distribute the surplus to those persons, and this obligation created “liabilities of the scheme” which had not been discharged as the surplus had not been used to augment benefits as required. The rules provided for limits on benefits to members and it may be that assets may be left over once members' benefits had been augmented up to those limits. However, the Panel had no information about what assets would be left over until Rule 9 had been complied with. The Panel dismissed the trustees’ argument that a potential entitlement of a beneficiary to participate in the distribution of surplus assets was not a “liability” of the Scheme.
Most defined benefit schemes are in deficit so it is unlikely that there will be many calls on the Regulator to exercise its statutory power to distribute a surplus to the employer. Whilst it is possible to sympathise with the trustees’ position that a potential entitlement of a beneficiary to participate in the distribution of surplus assets was not a “liability” of the Scheme, in the absence of an express power for the trustees to refund the surplus to the employer, as was the case here, the power under Rule 9 to augment benefits is likely to mean in effect that all the surplus had to be used to augment members’ benefits (up to any limits imposed under the rules) and therefore that the Panel’s assessment that this was a liability that had not been discharged was most likely an accurate one.
Pensions Ombudsman 6. Appeals from a determination of the Pensions Ombudsman and the Pension Protection Fund Ombudsman to require High Court leave
Appeals from a determination of the Pensions Ombudsman and the Pension Protection Fund Ombudsman may be made to the High Court on a point of law (but not on a point of fact) by the parties to the complaint. However, following concerns that this direct route to an appeal was being abused by parties seeking to appeal on matters of fact to the High Court, the Civil Procedure Rules are being amended so that appeals filed from 6 April 2014 will require leave to appeal from the High Court first.
This will now introduce an extra step for parties to go through if they wish to appeal to the High Court from a determination of the Ombudsman or the Pension Protection Fund Ombudsman. However, this extra step will allow the Court to weed out any appeals being sought on points of fact at the "leave to appeal" stage and so may in the long run save the parties time and unnecessary costs.
Legislation 7. Options extended for employers to provide minimum pension arrangements for transferred-in employees following a TUPE transfer
Originally intended to be in force from October last year, amending regulations have now finally been introduced that will extend the options available to an employer as to the minimum pension provision that it must make available to transferring employees following a TUPE transfer. The DWP had consulted on the issue in February 2013.
Under the current requirements, broadly, where transferring employees are members of a defined benefit occupational pension scheme or are entitled to membership of a defined contribution occupational pension scheme to which the transferor employer was paying contributions or was obliged to pay contributions, the transferee employer must currently provide one of the following pension arrangements, as a minimum, for the transferring employees:
- A defined benefit scheme which meets certain prescribed requirements.
- A defined contribution occupational scheme or a stakeholder pension arrangement to which the receiving employer must match the employee's contributions up to 6% of basic pay.
Since the auto-enrolment regime was introduced, however, concerns have been raised that these minimum contribution requirements are more generous than those required for DC arrangements under the auto-enrolment regime (currently 1% increasing to 3% from October 2018). This could result in the creation of a two-tier workforce, with employees who have been transferred in following a business transfer receiving more generous contributions from their employer (adding to employers' costs) than the rest of the workforce.
The amending regulations, to be in force from 6 April 2014, will add a further option, so that where the transferor employer had been required to make contributions solely for the purpose of providing money purchase benefits, the receiving employer, may provide, as a minimum, a stakeholder pension scheme or an occupational DC scheme to which it must match the contributions that the transferring employer was paying for those employees immediately before the transfer.
There were also concerns with the existing legislation that the employer could effectively get round the scope of its obligations to match employee contributions up to 6% of basic pay by setting a minimum contribution level for employees when joining the scheme. In the response to the consultation, the DWP has confirmed that employees should be able to choose the contribution they wish to make to the stakeholder pension arrangement or the occupational DC scheme.
The DWP has clarified (although not amended the legislation to make its intention clear) that the transferring employees can choose the level of contributions they make where the employer has chosen to meet its statutory obligations by providing an occupational DC scheme or a stakeholder pension arrangement matching a transferring employee's contribution up to 6% of basic pay. The legislation should therefore be interpreted in line with the DWP's intention.
When the legislation was originally introduced, there was a requirement for employers, in certain circumstances, to provide employees with access to a stakeholder pension arrangement. However, from 1 October 2012, the statutory requirement to provide a stakeholder pension scheme has been abolished (although legacy stakeholder pension arrangements are still very much in place). It would therefore have been helpful if the Government had amended the requirements so that as well as a stakeholder scheme, any defined contribution arrangement which an employer can use to meet its auto-enrolment obligations (such as a group personal pension plan or NEST) may be provided. The reason given for not making this change is that it is outside the scope of the specific questions which formed the basis of the consultation. However, the DWP has stated that it will monitor the interaction of the regulations with the introduction of automatic-enrolment and additional issues raised in the consultation and will consider them in due course.
European Perspective 8. Revised IORP Directive proposed
The European Commission has issued a revised IORP Directive, having begun its review of the Directive in 2011 and decided last year that the Solvency II-based rules for pension scheme funding should be dropped following overwhelming opposition from pension groups that, if adopted, the proposals would have significantly increased the liabilities of defined benefit schemes and result in employers closing and/or winding up those arrangements. Whilst those provisions are now not included in the revised Directive, the IORP Directive does still include the current requirement that cross-border schemes should be fully funded at all times. We will cover the Directive in more detail in our next bulletin. The proposed revised Directive may be found here.