A number of recent cases have changed the treatment of VAT on pension scheme third-party management services. This alerter sets out the current position and explains how schemes and employers can benefit from the 'special investment fund' exemption and the 'direct and immediate link' test. It also explains HMRC's current policy on reclaiming VAT on pension scheme management services.
The treatment of VAT on pension scheme management services is complex. The two key questions to consider are below:
- Is the scheme a 'Special Investment Fund' and therefore are third-party management services exempt from VAT?
- If the scheme is not a 'Special Investment Fund', to what extent can the employer recover VAT on third party management services?
What is the 'Special Investment Fund' exemption?
Under European law, the management of Special Investment Funds (SIFs) is exempt from VAT. This has been enacted into English law through the Value Added Tax Act 1994 which exempts the management services of authorised unit trust schemes, open-ended investment companies and closed-ended collective investment undertakings (such as investment trust companies) from VAT. There has been doubt over whether a common investment fund in which the assets of several pension schemes are pooled for investment purposes could be treated as a SIF. Recent cases suggest that defined benefit (DB) schemes are not SIFs, while defined contribution (DC) schemes do meet the criteria to be SIFs, provided certain conditions are met.
Defined benefit schemes
The Court of Justice of the European Union (CJEU) decided in Wheels Common Investment Fund v HMRC  that neither a defined benefit scheme nor a common investment fund in which the assets of several DB schemes were pooled constitute a SIF. It relied on the following to distinguish between common investment funds and collective investment undertakings (which are treated as SIFs):
- a collective investment undertaking is open to the public whereas a DB scheme is not; and
- in a collective investment undertaking the investment returns depend on the investment performance whereas in a DB scheme members do not bear the investment risk.
This means that management services in respect of DB schemes are not exempt from VAT.
Defined contribution schemes
The position is different for DC schemes. The CJEU ruled on 13 March 2014 in ATP Pension Service A/S v The Skatteministeriet (ATP) that an occupational DC scheme does constitutes a SIF, provided the scheme:
- pools the assets of several beneficiaries where the beneficiaries bear the investment risk; and
- allows the spreading of risk over a range of securities.
Therefore, assuming these conditions are met, DC schemes are exempt from VAT in relation to third-party management services, including investment services. This is a major shift in the legal position and is likely to result in considerable savings for many DC schemes.
If the scheme is not a 'Special Investment Fund', when can an employer recover VAT?
In PPG Holdings BV (C-26/12)  (PPG) the CJEU ruled that VAT charged on scheme management services, including investment management services, could be deducted as input tax by an employer provided there is a 'direct and immediate link' between the services and the employer's economic activities as a whole.
It held there would be such a direct and immediate link where the cost of input services (i.e. the cost of the pension scheme management services) is incorporated into the cost of the goods or services supplied by the employer as part of its economic activities. Although the ultimate decision rests with the member state courts, the judge suggested that it seems likely that if the employer established the scheme and paid for the management services, this 'direct and immediate link' test would be met.
Whilst the legal position (as outlined above) is important, in practice schemes and employers may be inclined to follow HMRC's policy on VAT.
HMRC's current position is that neither DB nor DC schemes constitute SIFs and therefore any third party scheme management services are not exempt from VAT. However, we expect HMRC will update its policy shortly to reflect the CJEU's recent decision in ATP that DC schemes do constitute SIFs provided certain conditions are met.
Following the CJEU's decision in PPG, HMRC has changed its policy on when VAT on scheme investment management services may be recoverable. Previously it allowed employers to recover VAT on fund administration related services but not on investment management services. Where a single invoice included a mix of administration and investment management services, HMRC allowed the employer to claim 30 per cent of the VAT as relating to the general management of the scheme
With effect from February 2014 (and subject to a six-month transitional period), provided the supplies are made to and paid for by the employer and are not solely in relation to investment management services, HMRC permits employers to deduct VAT in relation to pension fund investment management activities as general costs. In particular, services which 'go further than the management of the investments' may be general costs and therefore VAT charged on them deductible by the employer.
The diagram below summarises HMRC's position on VAT on scheme management services.
Click here to view image.
The CJEU's decision in ATP means all management services (including investment related services) in relation to pure DC schemes are exempt from VAT on the basis the scheme qualifies as a SIF. Following the decision in PPG, employers of DB schemes will be able to reclaim VAT on scheme management services, including investment related services, provided the employer established the scheme, the services are supplied to and paid for by the employer and do not relate solely to investment services.
These recent changes on VAT treatment mean that many DC and DB schemes and their employers are likely to benefit from reduced pension management charges. Employers may also be entitled to reclaim significant amounts of overpaid VAT where they have been invoiced for both management and investment services in the last four years. The savings in relation to DC schemes are likely to be greater following the CJEU's decision in ATP.
We anticipate that many DB schemes will try to ensure that management services (especially investment related services) are structured in order to maximise the benefits that can be gained from the changes in law and HMRC's policy. For example, altering billing arrangements so that services are supplied to and paid by the employer and incorporating investment management services into invoices for administration services. However, it may not always be possible to incorporate investment services in this way. For example, if the supplier is only instructed to provide investment management services.
Many trustees have arrangements in place so that invoices in respect of management services are addressed to the trustees but specify that they are payable by the employer. It is unclear whether HMRC will accept that in these cases the services have been 'supplied' to the employer. If such arrangements do not meet HMRC's requirements, the gains from the recent changes on VAT recovery may be limited as suppliers may not be willing to address invoices to employers when their client is the trustees. An alternative option for corporate trustees is to investigate the benefits of registering for VAT within the same VAT group as the employer. In this scenario, VAT incurred on supplies to the corporate trustee can be treated as received by the representative member.