On 25 November 2014, HMRC issued its long-awaited response to the decisions in PPG Holdings[1] and ATP Pension Services[2] in the form of Revenue and Customs Briefs 43 (2014) and 44 (2014). In the latest instalment of this long-running VAT recovery saga, HMRC seems to have opened the door to claims for refunds, prompting some commentators to predict a £2 billion windfall for pension schemes. However, on closer inspection, it looks as though many pension schemes will find themselves disadvantaged and may end up worse off under the new rules.

A tale of two cases
Key principles emerging:

  • Defined Benefit (and Defined Contribution) schemes – employers can recover VAT on services where there is “a direct and immediate link” between the service provided and the employer’s own taxable supplies (PPG Holdings)
  • Defined Contribution – pooled investments in schemes may correctly be regarded as a Special Investment Fund and are therefore exempt from VAT (ATP Pension Services)

HMRC’s new policies

HMRC Brief 43 (2014)
The fundamental change is that HMRC no longer distinguishes between day-to-day administrative costs (VAT on which was previously deductible) and costs incurred relating to the investment management of assets of the scheme (VAT on which was not previously deductible). Instead, the employer will potentially be able to deduct input VAT if it receives the supply of services of either type. In determining who receives the supply of services HMRC states that the fundamental criterion to be established is “economic reality” and the actual recipient of the supplies. HMRC says the employer must produce contemporaneous evidence that the services are provided to the employer and in particular that the employer is a party to the contract for those services and had paid for them.

HMRC permits as a transitional arrangement the continuation of invoices being split where a scheme receives both administrative and investment management services. In this case the 30%/70% split can be applied, with VAT on 30% of the invoice being treated as referable to administrative services and therefore recoverable.

The good news is that it is now possible for an employer to deduct input tax where it couldn’t before. HMRC has finally conceded that it is not reasonable to maintain a distinction between the administration of a pension scheme and the management of its assets. Therefore any employer who can meet the new criteria can deduct input VAT without needing to distinguish between administration and investment costs.

The bad news is that HMRC appears to be giving with one hand and taking considerably more with the other. It is not certain that schemes which have previously been able to deduct VAT with regard to some services will be able to continue to do so, due to the new HMRC requirement for the services to be commissioned and received by the employer. In assessing whether the services have been received by the employer, HMRC believes that the most useful starting point is to examine the agreements between the parties. The problem lies in the fact that in many cases advisers’ contracts are with the scheme trustees and not the employers themselves. If HMRC’s view prevails this could represent a significant increase in employers’ costs of running DB schemes. It remains to be seen whether HMRC’s interpretation of the decision in PPG Holdings is legally correct.

HMRC Brief 44 (2014)
In light of the ATP judgment HMRC now accepts that pension funds that have all of the following characteristics are Special Investment Funds (SIFs) for the purposes of the fund management exemption and so all the services of managing and administering those funds should be, and always should have been, exempt from VAT. Those characteristics are:

  1. They are solely funded (whether directly or indirectly) by persons to whom the retirement benefit is to be paid;
  2. The pension customers bear the investment risk;
  3. The fund contains the pooled contributions of several pension customers; and
  4. The risk borne by the pension customers is spread over a range of securities.

Only fund management and administration services that are integral to the operation of the pension fund will qualify for exemption.

Brief 44 is likely to have much less impact on pension schemes than Brief 43 but there are still issues around certainty. For example it is unclear what HMRC means by “solely funded” by persons to whom the benefit is to be paid. Furthermore, it does not change the fact that defined benefit schemes’ investment funds are not SIFs as found in Wheels.

Claims and retrospective action

  • It will be possible to claim a refund of VAT already paid subject to the usual rules on capping (claims for repayment will not be considered for periods ending more than 4 years before the date on which the claim is made).
  • Claims should provide clear evidence and provide copies of any documentation used to calculate the claim on request.
  • In relation to claims made under the changes outlined in Brief 44, HMRC may reject all or part of a claim if it takes the view that repayment would unjustly enrich the claimant (for example, if it was not the claimant who bore the burden of the tax in question).

Next steps

  • Schemes should take steps to protect their position and seek legal/tax advice as soon as possible on their current billing arrangements to optimise the VAT position.
  • It would not be wise to continue to rely on the transitional provisions without first checking with HMRC, given that the description of the transitional provisions in HMRC Brief 43 is vague.
  • Employers should review whether refunds can be obtained and apply to HMRC as soon as possible, producing all necessary evidence.

Where possible consider restructuring how schemes outsource their administration and how contracts with service providers might be bought within the new rules.

By Katie Turney

[1] Fiscale Eenheid PPG Holdings v Inspecteur van de Belastingdienst (Case C-26/12)
[2] ATP Pension Service A/S (Case C-464/12)