UK: HMRC Amends Policy To Allow DB Employers To Recover VAT On Certain Investment Activity Costs

Summary and implications

HMRC has published a briefing (Brief 06/14) stating its revised policy on the ability of sponsor employers to recover input VAT incurred in the management of defined benefit (DB) pension schemes. This policy has been updated to implement the recent ruling in PPG Holdings BV.

• Albeit grudgingly, HMRC now accepts there is greater scope for DB pension scheme employers to reclaim input VAT on the costs of investment management services where they are provided alongside administration services. This may result in a material saving for scheme employers who can offset this against their output VAT.
• Employers may also be entitled to reclaim significant amounts of overpaid VAT where they have been invoiced for both management and investment costs in the last four years and should consider making any such claims as soon as possible.
• Since there will no longer be an assumed 70/30 split for combined invoices, scheme employers will have to justify the amount of VAT claimed on mixed invoices. They may find they cannot recover as much as they would have previously.

HMRC's previous policy and the 70/30 split treatment

Previously, HMRC distinguished between costs incurred in relation to the general administration of pension scheme, and costs incurred in the management of the scheme's investment activities. It only permitted employers to recover VAT incurred on the former.

Where a single invoice was issued which covered both general management and investment services, HMRC accepted that the employer was entitled to attribute 30 per cent of the VAT to general management. The pension fund was entitled to reclaim the remaining 70 per cent but only if it made taxable supplies. That was unlikely.

VAT recovery: management and investment costs of a pension fund
Our previous briefing on the case of PPG Holdings BV. More

CJEU's decision in PPG Holdings BV

In July 2013 the European Court (CJEU) held in the case of PPG Holdings BV (PPG) that an employer is entitled to recover VAT on the cost of both general management and investment services so long as there is a "direct and immediate link" between that expenditure and the taxable activities of the employer. In other words, the cost of the services received must be incorporated into the price of the supplies made by the employer.

HMRC's new policy

Responding to this judgment, HMRC has now withdrawn the 70/30 split treatment and confirmed that "there are circumstances where employers may be able to claim input tax in relation to pension funds where they could not previously". However HMRC has not yet offered any examples of what circumstances these might be.

There are circumstances where employers may be able to claim input tax in relation to pension funds where they could not previously.

In its briefing, HMRC highlights the principle that an employer can only deduct VAT incurred on costs relating to a pension fund where there is a direct and immediate link between the supply received and the supplies it makes.

In the view of HMRC, VAT incurred in relation to pension fund management or administration will not be deductible where:

• the supplies have not been made to the employer; or
• the supply is limited to investment management services only and is not a combined supply of both investment management and pension administration services.

In addition, if an employer receives the services but passes the costs to the pension fund then an equivalent amount of output VAT in respect of those amounts must be accounted for on the supply from the employer to the pension fund.

HMRC has made it clear that in its view specific investment costs cannot be general costs of the employer as they have a direct and immediate link to the supplies of the specific investments themselves. HMRC argues that these costs are therefore not VAT deductible for the employer.

However, HMRC has acknowledged that where investment-related services "go further than the management of investments" they may be general costs of the employer and may be incorporated into the price of the taxable supplies it makes. If so, VAT incurred on them may be recoverable.

Retrospective and future action

HMRC's new policy is effective from 3 February 2014, although there is a six-month transitional period during which pension funds and employers may still agree to a 70/30 split where the pension fund is invoiced for services.

AG opinion: management services for DC pension schemes are VAT exempt
Briefing on the Advocate General's opinion on the ATP PensionService case. More

HMRC has confirmed it will accept retrospective claims for overpaid VAT where both general management and investment management costs were invoiced to the employer. Such claims are subject to the normal four-year limitation period. Where a 70/30 split has been used in the past, care will be needed with regard to any VAT already claimed by the pension scheme as well as that claimed by the employer.

In its briefing HMRC notes that the CJEU's decision is still pending in regard to the ATP PensionService case which has raised questions regarding the issue of VAT paid on investment management services under defined contribution (DC) schemes. HMRC warns that if the court holds that VAT should not have been charged on such services then it will take "appropriate steps" in the future to recover any VAT deducted that was incorrectly charged.

Comment

HMRC has confirmed that it will update its VAT Notice 700/17 shortly to reflect these changes and this may provide further explanation as to what effect this policy change will have in practice. It may also provide some useful examples to illustrate circumstances which will or will not result in investment costs being VAT deductible.

In the meantime, employers should consider whether they are entitled to reclaim any VAT paid in relation to their pension schemes following this policy change and, if so, should get their claims in as soon as possible.

Since the ability of employers to reclaim VAT on investment management services now clearly depends on whether the services are supplied directly to the employers and whether they are provided separately or alongside other management services, employers may also need to give some thought to how the investment management services for their pension schemes are organised.

This briefing is unlikely to be the last word on the recovery of input tax on pension schemes. HMRC has arguably taken a very narrow interpretation of PPG and a number of employers are already restructuring their arrangements to achieve total recovery. Whether they or HMRC are correct will doubtless be decided in the courts.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.