HMRC has changed its policy on reclaiming VAT on defined benefit pension fund management costs, according to a brief it released this week.
Based on the Court of Justice of the European Union (CJEU) ruling concerning Dutch industrial group PPG Holdings BV, the Revenue has changed its stance, meaning there are circumstances where employers may be able to claim VAT in relation to pension funds where they could not previously.
Associate director at Baker Tilly David Wilson had previously identified that this ruling meant that those implementing auto enrolment schemes could reclaim VAT if the scheme adhered to certain conditions.
But, he added that there is room for a wider interpretation of PPG by HMRC, “particularly in light of mandatory auto enrolment which would appear to put UK employer pension funds on the same footing as the Dutch pension funds ruled upon by the European Court.”
The CJEU had ruled last July that subject to these conditions, an employer should be able to reclaim VAT on both the day-to-day management of a pension scheme and management of investments, where the fund is a legally and fiscally separate entity.
It ruled that pension fund management and operation costs are costs of the employer.
Therefore, if it can be proven that there is an immediate link between those costs and a business’ taxable activities, an employer setting up a pension fund as a legally and fiscally separate entity can deduct the VAT it has paid on services relating to the management and operations of that fund.
The Netherlands applies a mandatory pension scheme similar to auto enrolment in the UK, which is being phased in over the next five years.
The CJEU ruled that:
- To deduct the VAT incurred on a cost, a business must establish a direct and immediate link between the supply received and the taxable supplies that the business makes
- Whether there is a link will depend on whether the cost of the input services is incorporated in the price of the supplies made by the business. A cost may either be incorporated in the price of specific supplies or groups of supplies, or be part of its general costs and incorporated in the price of all the supplies made by the business
- If a cost has a direct and immediate link to specific supplies or groups of supplies, then it cannot also be part of its general costs
- Specific costs of investment management will have a direct and immediate link to the supplies of the investments themselves
- But where the services received go further than the management of the investments, they may be general costs. Therefore, provided that the supply is received by the employer, the VAT incurred will potentially be deductible by the employer
While the Revenue is changing its policy, it added that it will not accept that the VAT incurred in relation to pension fund management/administration is deductible by an employer in the following circumstances where the:
- Supplies were not made to the employer (including consideration of whether the employer has commissioned and paid for the services)
- Supply is limited to investment management services only (i.e. it is not a combined supply of both investment management and pension administration services)
Additionally, where the employer receives the supply but the pension fund bears the cost of the services (whether by way of reimbursement or a set off against pension contributions), HMRC will require an equivalent amount of output VAT in respect of the amounts reimbursed to be accounted for. This amount is potentially deductible by the pension fund to the extent that it is engaged in taxable business activities.
HMRC will allow a six-month period to adapt to the changes.
Businesses that provide pension schemes for their employees and receive supplies of services that fall within the above criteria are entitled to claim a refund of any input VAT which has not previously been claimed.
Baker Tilly's David Wilson advised that the case for reclaiming VAT on auto enrolment schemes still stands: "Under auto enrolment, pension funds will be mandatory for the employer. That places responsibility with them to fund the costs, which means that employers set up pension funds as a separate legal entity - that must make a difference going forward,” he said.
"My line of thought is that if it is incumbent on employers to establish employees funds then there must be a direct link to the economic activities - ergo why shouldn’t employers be entitled to recover cost of admin and set up of pension funds?"
In his previous analysis of the case, Wilson predicted £1.9bn worth of a potential VAT windfall for employer pension schemes.
He added that this is still a reality - albeit as there is another ongoing case included within that figure.
"This business brief only impacts on defined benefit pension schemes. There is another case (ATP services) which addresses whether services to defined contribution schemes should be subject to VAT.
"If this is successful and you take the two cases combined, then yes there’s a potentially huge VAT windfall. But there is a long way to go and one of things to be considered is that HMRC would appear to have narrowly interpreted the PPG judgement,” he said.
