HMRC's new policy on VAT and pension schemes

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        <p>Update&nbsp;&nbsp;</p>
        <p>Changes made to HM Revenue &amp; Customs (HMRC) Manuals in November 2017 make it clear that the existing option to recover input VAT in relation to employer funded pension costs on the basis of a 70:30 split between investment services and administration will continue to be available and will not now be withdrawn from 01 January 2018 (see <a href="https://www.gov.uk/hmrc-internal-manuals/vat-input-tax/vit44600" target="_blank">VIT44600</a>). HMRC guidance in the VAT Input Tax (VIT) Manual notes that &ldquo;in consideration of the difficulties encountered by some taxpayers with implementing options that would allow appropriate deduction of VAT as per PPG, HMRC has come to the view that the existing rules for input tax deduction will continue to be available to taxpayers going forward, together with the newer options following &ldquo;. For further details on the background to the changes, see <a href="http://www.elexica.com/en/legal-topics/tax/26-hmrcs-new-policy-on-vat-and-pension-shcemes">HMRC&rsquo;s new policy on VAT and pension schemes</a>. </p>
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HMRC have announced that they will, in principle, allow input VAT recovery where an employer receives a supply of pension fund administration or investment management following the ECJ decision in PPG. Revenue & Customs Brief 43/2014 replaces announcements from earlier this year and potentially allows VAT recovery for employers funding occupational pension schemes on a wider basis than was previously the case. However, much will depend on how the new policy is applied in practice by HMRC and doubts remain as to the circumstances in which HMRC will accept that supplies of administration and investment management are actually received by the employer (rather than the fund itself). In addition, recharging of costs by an employer to a pension fund may well result in a worse VAT outcome under the new policy.

At the same time, HMRC have also announced that they will implement the ECJ decision in ATP PensionService and exempt fund management supplied to defined contribution schemes and personal pension schemes that have similar characteristics to those in the ATP case: Revenue & Customs Brief 44/2014.

Both announcements raise the possibility of significant VAT reclaims - of under-deducted input VAT by employers or overpaid output VAT by pension fund managers and/or pension schemes - subject to the usual four year cap. It is important, therefore, that affected businesses should consider their position and, where appropriate, bring claims as early as possible to protect their position.

Background

Historically, HMRC has taken the view that where an employer funds an occupational pension scheme, it is necessary to distinguish between the costs of setting up and day to day administration of the scheme and the payment for the (usually sub-contracted) management of the investment activities of the fund. HMRC accepted that the former amounted to deductible overheads of the employer’s business for VAT purposes, but considered that any VAT on supplies of investment management services to the scheme related solely to the activities of the pension scheme and could not be deducted by the employer. Where a single invoice was received, covering both administration and investment management, HMRC would in general allow a 70:30 split (70 per cent investment management, 30 per cent administration).

In PPG Holdings, the ECJ held that, provided a direct and immediate link exists between the pension fund costs and the employer’s business, then input VAT incurred by the employer on pension fund administration and fund management would be deductible. As usual, the ECJ left the question of whether there is such a direct and immediate link to the national court to determine.

HMRC accepted that this decision required a change in current policy, but originally took the view (in Revenue & Customs Brief 06/14) that VAT on investment management could not be attributed to the employer’s business. However, following discussions with industry, HMRC announced (in Revenue & Customs Brief 22/14) a suspension of their earlier announcement pending further consideration and that employers could continue to use the 70:30 split basis in the meantime.

As regards the exemption for fund management, HMRC have historically taken the view that pension funds do not qualify as “special investment funds”. The ECJ decided, however, in ATP PensionService that a pension fund which pooled investments from a number of defined contribution pension schemes could be a special investment fund so that services supplied to it may qualify as exempt fund management.   

Employer funded pension costs

Revenue & Customs Brief 43/2014 announces a change of policy by HMRC in relation to the recovery of input VAT by employers in relation to management of pension funds. HMRC now accept that where an employer pays for and receives a supply in relation to an occupational pension, then the employer may be able to recover that input VAT. In particular, in a significant change of policy, HMRC now accept that “there are no grounds to differentiate between the administration of a pension scheme and the management of its assets”. Accordingly, provided that the employer can show that it is the recipient of the supply, it will be entitled to input VAT credit. However, the proviso in this case is all important and it remains unclear in what circumstances HMRC will accept that supplies of investment management, or even administration, are actually received by the employer, rather than the fund itself.

In this context, the Brief indicates that it will be important for an employer to obtain “contemporaneous evidence that the services are provided to the employer”. At minimum, this will require the employer to be a party to the contract for the relevant pension services and also to pay for the services. Overall, HMRC will look to the “economic reality” of the arrangements, but accept that payment is an important indicator of who receives the supply.

Nevertheless, the advantageous treatment still will depend on the employer showing that it is the recipient of the supply and it may still prove difficult to show in practice that the employer receives the relevant supply, particularly in relation to a supply of portfolio management services relating to the scheme assets. It is far from clear that HMRC will treat the employer as recipient simply on the basis that the employer is party to the relevant contract and pays for the services.  If the employer cannot be shown to receive the supply in question, then this will result in a worse VAT position than the current 70:30 split.

If an employer receives supplies of pension administration or investment management services and recharges the cost to the pension scheme, HMRC indicate that this will involve an onward taxable supply of services in consideration for the recharge. Currently, HMRC do not view recharged “management services” as giving rise to an output VAT liability, as these costs are the employer’s own business costs (VIT44900). Accordingly, it appears that HMRC may seek output VAT on recharges in a wider set of circumstances than previously. In practice, recharged costs may well simply give rise to irrecoverable input VAT at the level of the pension fund.

HMRC accept that the previous policy in relation to employer funded pension services was incorrect, but will not seek to recover any over-recovered input VAT by employers under the 70:30 policy (for example, where an employer was not party to the relevant contracts). In addition, to enable a transitional period to allow businesses to adapt to the change in policy, HMRC will continue to allow businesses to use the 70:30 split until 31 December 2015.

Defined contribution pension schemes

In Revenue & Customs Brief 44/2014, HMRC have now accepted that pension funds with similar characteristics to the fund in the ATP case qualify as “special investment funds” for the purposes of the VAT exemption for fund management. These will include defined contribution occupational pension schemes or pooled personal pension schemes with the following characteristics:

• they are solely funded (directly or indirectly) by the pension customer
• the pension customer bears the investment risk
• the fund contains the pooled contributions of “several pension customers”
• the risk is spread over a range of securities.

There are restrictions on how widely HMRC will accept the exemption applies, however. The exemption will not cover the situation where an “individual investor is able to give directions as to how their contributions are invested (eg in specific assets and/or funds external to the pension fund)”. Where pension schemes pay members’ contributions into a number of different funds, exemption will only apply to services supplied in connection with funds that would themselves qualify as special investment funds. Where the contributions of a number of schemes are paid into a single fund, it will be necessary to consider whether that fund as a whole possesses the necessary characteristics. Equally, where investment management or administration services are supplied to a scheme that has a number of funds, some that possess the characteristics of a special investment fund and others that do not, to determine the correct VAT treatment of the services in question it will be necessary to apply the rules on single/multiple supplies.

UK legislation will be amended in due course to implement the ATP judgment, but taxpayers may, of course, rely on their directly effective EU rights to claim exemption in appropriate cases. In addition, HMRC note that they are still considering whether the ATP decision may have “wider application” and will release guidance if there are to be any further changes.

VAT reclaims

Both Briefs raise the possibility of significant reclaims of VAT.

Employers who have reclaimed input VAT based on the 70:30 split may wish to consider if, following HMRC’s acceptance of the PPG judgment, they were entitled to higher levels of input VAT recovery and claim for any under-deducted input VAT, subject to the four year cap. HMRC will require detailed calculations of the under-deduction and it will be necessary for the employer to be able to show that they were the recipient of the supply (rather than the pension scheme).

Suppliers of fund management services to pension funds which have the characteristics set out in Brief 44/2014 and have been charged output VAT on their services may seek to reclaim overpaid output VAT, subject to the four year cap. Such claims would potentially be subject to the unjust enrichment defence and to adjustment for over-recovered input VAT. Indeed, fund managers in this position may wish to make protective claims to limit their exposure to corresponding contractual claims from pension schemes in relation to overpaid VAT. Equally, as with the investment trust VAT aftermath, pension schemes themselves may have the possibility of reclaiming overpaid VAT directly from HMRC where recovery from the fund manager does not adequately compensate them (see Investment Trust Companies v HMRC).

However, it is notable that both Briefs make clear that HMRC will not accept estimated claims for repayment of VAT. HMRC will require that claims must be supported with a high level of information, in particular differentiating the type of fund, detailing the investment management supplies made, etc. In particular, HMRC state that estimated claims will not stop the four year clock, suggesting that HMRC will take a stringent approach on the raft of claims that have already been filed in relation to these two types of claim? Few existing claims are likely to have complied with the terms of these Briefs.

Update

HMRC has since extended the transitional period for using the 70:30 basis of VAT recovery until 31 December 2017. See "HMRC extend transitional period for employer funded pension VAT costs".