European Union: European Court In £2 Billion Blow To UK Pension Schemes

The European Court of Justice (ECJ) has handed down a ruling in the case of Wheels Common Investment Fund Trustees Ltd v HM Revenue and Customs which confirms that UK defined benefit pension schemes are liable for an estimated £2 billion worth of VAT on investment management services. The pensions industry had been hoping that the Court would allow schemes to recoup this sum from HM Revenue and Customs.

The case

The case was brought on behalf of several occupational pension schemes in the Ford Motor Company's corporate group. Wheels Common Investment Fund Trustees Ltd was the trustee of the schemes' assets, which were aggregated into a common pool for investment purposes.

The relevant EU Directive (like its predecessor) requires the UK not to levy VAT on the "management of special investment funds". The definition of "special investment funds" is left to the individual Member States to define.

The UK Government last revisited the question of which investment vehicles are exempt from VAT by virtue of being "special investment funds" after the earlier ECJ judgment in the case of JP Morgan Fleming Claverhouse Investment Trust v Association of Investment Trust Companies [2007] ECR I-5517. The Government laid down that VAT was not chargeable on the management of collective investment undertakings which took the form of authorised unit trusts and open-ended investment companies, or on the management of closed-ended collective investment undertakings such as investment trust companies. The Government did not, however, change the law so as to exempt occupational pension schemes from VAT on investment services.

In this case, the claimants attempted to argue that this was unlawful. HMRC initially rejected their challenge in January 2008. Wheels appealed to the First-tier Tribunal (Tax Chamber), and the Tribunal in turn referred the issue to the ECJ. The issue at stake was whether the pool of pension fund assets held by Wheels was a "special investment fund".

The ECJ noted that the UK Government had the power to define what a "special investment fund" was for the purposes of UK law. It stressed, however, that this power was not unlimited. It held that the question was "whether an investment fund in which the assets of a retirement pension scheme are pooled... is identical to funds that constitute "special investment funds"... or is sufficiently comparable to the latter to be in competition with them".

The ECJ found that the answer to this question was No. Unlike other investment vehicles, an occupational pension scheme is not open to the general public. Moreover, the members of a defined benefit pension scheme are not incurring any risk in relation to the investment of the scheme assets, since the level of their benefits is, by definition, fixed in advance. The employer who funds the scheme is incurring a risk, but the ECJ noted that such an employer can be distinguished from other investors in the market insofar as the employer is funding the pension scheme purely in order to deliver on a legal commitment which it has made in respect of its employees.

Clyde & Co Comment

This was a test case backed by the National Association of Pension Funds. The NAPF's Chief Executive, Joanne Segars, described the result as "deeply disappointing", a sentiment that will be shared by others in the pensions industry. At a time of steep pension deficits and general economic hardship, the ECJ's ruling will come as unwelcome news to many people. Ms Segars noted that the policy intention in the UK had always been that occupational pension schemes would be free from tax. By contrast - and predictably - the ruling was welcomed by HMRC.

There are certain limits to the effects of the ruling. In particular, it extends only to defined benefit occupational pension schemes, and not to defined contribution occupational pension schemes, personal pension schemes or other retirement savings vehicles. In addition, the European Commission is currently reviewing the VAT Directive. It remains to be seen whether any changes will be made to it in the light of the ECJ's ruling.

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