Martin Sharratt discusses the contentious situation relating to VAT exemption for pension funds and the latest test case being considered by the European Court.
The management of a pension fund is, in one sense, clearly a form of investment activity and from a layman's perspective it looks very much like something that ought to fall within the VAT exemption. However, as most of our clients will appreciate, VAT has its own logic and this is a subject which has confused experts and HMRC alike for decades.
Scope of exemption
The scope of the exemption is set by European legislation, which restricts the exemption for fund management services to "the management of special investment funds as defined by member states".
The European Court of Justice (ECJ) has ruled several times on the meaning of this phrase, first pondering at great length which services constituted "the management" and then (in 2007), in the JP Morgan Claverhouse case, ruling on how much discretion individual member states had in deciding which forms of investment fund should benefit from the exemption.
The ECJ held that the UK had applied the exemption too narrowly and that the management of an investment trust company should also be exempt. Following that decision, HMRC considered the implications for other investment vehicles and accepted that, to avoid distortion of competition, the exemption should be extended to several other forms of collective investment scheme – but not pension funds.
Test case
In the four years since the JP Morgan Claverhouse case there have been rumblings about a further test case which would challenge HMRC on this point and decide once and for all whether the management of a pension fund should, like the management of an investment trust, have been exempt all along. The name of the appellant, it was eventually revealed, was The Wheels Common Investment Fund Trustees Limited, joined by the National Association of Pension Funds.
The amounts of tax at stake are substantial and numerous backdated claims have been submitted, all of which have been 'stood over' and await the test case. The case has progressed slowly, however, and it was early in 2011 when it emerged that it had been heard by the Tax Tribunal, which had agreed that the matter should again be referred to the ECJ (or the Court of Justice of the European Union (CJEU) as it is now known). Again, there was a long wait while the parties deliberated on the wording of the questions, but the referral has now been made and the questions are in the public domain.
The appellants argue that, although not open to the public, occupational pension schemes do constitute a form of collective investment vehicle for the employers and employees, and as such fall within the meaning of "special investment funds".
The Wheels pension fund is a defined benefit scheme, however, and one of HMRC's strongest arguments is based on the "disconnect" (sic) between the amounts received as a pension by employees (fixed by reference to salary and length of service), and the amounts the employee pays into the pension fund and its investment return. It will be many months before we know how the CJEU approaches the issue or whether this distinction is relevant.
Legislative changes?
Meanwhile, the member states and the European Commission have been reviewing in depth how the VAT exemptions should work in the financial sector, with a view to updating the Directive and clarifying some of the contentious points. Many of these proposals have been fiercely resisted and will never see the light of day, but one, which has apparently survived multiple redrafts of the new Directive and seems to be accepted by all, would make the management of a pension fund exempt after all.
Pension fund managers, trustees and employers will need to keep an eye on these developments and should be thinking of lodging a protective claim for the VAT previously charged on the fund management services if they have not already done so. They should not, however, expect the final outcome any time soon.
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