Pension funds, investment risk and VAT exemption

The CJEU has held that, for the purpose of determining whether pension funds were comparable to UCITS, members will only bear the requisite investment risk where the pension amounts depend primarily on the performance of the pension investments: X and other v Inspecteur van de Balastingdienst Maastricht (Joined Cases C-639/22 to C-644/22). Although the final salary pension benefits in these cases could depend, to some extent and indirectly, on investment performance, to the extent that the pensions depended fundamentally on length of employment and final salary, this would mean that the pension funds did not meet the “investment risk” requirement to be comparable to UCITS.

Background

In principle, Member States have the power define what are “special investment funds” (SIFs) for the purpose of Article 135(1)(g). However, the CJEU has historically held that Member States do not have complete discretion and the definition of a SIF should align with a UCITS or funds which are comparable with a UCITS. Furthermore, in Wheels and ATP PensionService, the CJEU held that defined benefit pension funds do not fall within the definition of SIFs. In particular, the CJEU considered that it was an essential feature of a SIF that the beneficiaries bear the investment risk of the fund assets, which is not the case with a defined benefit scheme.

The Dutch courts have now referred to the CJEU a series of five further cases involving employee pension schemes with varying features in an attempt to further refine the definition of a SIF for VAT purposes. Each of the cases involve an occupational pension scheme for a particular industry sector (for example, the food sector) and participation of employees is compulsory. The basis for the pension payable under the arrangements is essentially the level of employment income and years of service (a defined benefit scheme). Each are subject to State supervision, including requirements over the policy coverage ratio. Under such schemes, employees accrue pension rights adjusted annually on the basis of CPI, but any such increase must be covered by investment returns. In addition, no increases may be granted if the coverage ratio falls below certain levels. In an extreme case, the pension fund may be required to reduce pension benefits, due to a low coverage ratio. Finally, in Case C-641/22, the employer had guaranteed certain amounts to cover targeted pension accrual and in C-640/22, there was no longer any active accrual of assets.

Decision of the CJEU

The decision of the CJEU focusses on the concept of whether the pension holders bore investment risk. In Wheels, the pension fund was not considered a SIF since the pension “does not depend at all on the value of the scheme’s assets and performance of the investments… but is defined in advance on the basis of length of service with the employer and the amount of the salary”. In the referred cases, whilst the pension benefits primarily depended on the final salary and length of service, the pension benefits could, to some degree, indirectly depend on investment performance, due to the link with the coverage and its impact on indexation of benefits or possible reduction of benefits. Was this sufficient to differentiate the position to that in Wheels?

The decision of the CJEU makes it clear that to meet the test of “investment risk” for the comparability analysis, it is necessary that the pension received should depend on the investment made by the fund to an extent comparable to that which the returns of holder of units in a UCITS does. As such, the performance of the investments of the retirement fund would need to have a significant impact on the amount of the pension entitlements. They must depend “primarily, positively or negatively, on the performance of the investments made by that fund”. The CJEU makes it clear that will not be the case where the amount of pension entitlements are broadly predefined according to length of service and the amount of salary.

However, the CJEU did make it clear that where the pension entitlements do, on the facts, depend significantly on investment performance, then it is immaterial whether that risk is spread across all members of the pension fund. Such a situation would naturally result from pooling and would not prevent that risk affecting entitlements.

Fiscal neutrality

The CJEU was also asked to consider whether, in essence, the pension funds could rely on the principle of fiscal neutrality to argue that they should be treated as SIFs where they were comparable to other funds treated as SIFS under Dutch law (even if those funds were not UCITS or comparable with UCITS). In particular, the Dutch tax authority had, by guidance, provided that an “individual defined contribution pension scheme” (IDCPS) constitutes a SIF.

On this point, the CJEU has held that fiscal neutrality can (essentially) cascade. The Court had indicated that it would be necessary for the domestic courts to consider not only whether the pension funds in this case are comparable to UCITS, but also whether they are comparable to other funds, which whilst not themselves UCITS, are regarded by the relevant Member State as being special investment funds.

Comment

It will not come as any surprise that the CJEU has held that the Dutch defined benefit pension schemes do not, in principle, fall within the scope of SIFs so as to benefit from VAT exempt management. The requirement to bear investment risk (so as to be comparable with UCITS) is of a nature comparable with the investment risk in a typical UCITS and that is fundamentally different to a residual risk of defined benefits being indirectly affected by investment performance.

The CJEU, unlike the AG, did not consider other factors in its decision. For example, the AG opinion suggested that the AG would also have considered the pension funds as failing the comparability test on the basis of the limited range of investors to which they were open. According to the AG, funds should be “open to an unlimited number of investors” to meet the comparability requirement. It is not entirely clear how to interpret that suggestion by the AG, when clearly many current SIFs have some form of restriction on the investors to which they are open. To be open to the public, a fund must be open to an unlimited number of investors. The pension funds in this case were only open to a limited number of investors, employees from the relevant sectors. Furthermore, pension holders did not have redemption rights which were comparable to UCITS. The AG also considered the fact that such pensions were compulsory was also a distinguishing feature of significance.