Last summer, the European Court ruled (in PPG Holdings BV (C-26/12)) that VAT payable on services provided for a Dutch pension fund was deductible by the employer if certain conditions were met. Since then, the HMRC has issued a keenly awaited announcement in response to the ruling.
It is important to note that this announcement relates to defined benefit pension schemes (the announcement notes that a CJEU ruling as regards defined contribution schemes is expected soon).
What was the position before HMRC's announcement?
HMRC had previously allowed employers to deduct VAT regarding costs incurred in relation to the day-to-day setting up and administration of an occupational pension scheme, as these were considered to be overheads of the employer and therefore a direct and immediate link to the employer's business activities.
As regards costs relating to the investment management activities of the pension fund, however, to the extent that those were VAT deductible, it was for the trustees to seek that deduction rather than the employer. It used to be the case that where a single invoice was received covering both the administration (day-to-day management costs) of the pension fund and the management of the investments in the fund, HMRC allowed the employer to claim 30% of the VAT relating to the general management of the scheme and the pension fund trustees to claim 70% in relation to the investment management.
What has changed?
Following the PPG case (please see below), HMRC has now decided to withdraw the 30/70 split. However, where the pension fund is invoiced for services, there will be a transitional period of six months during which the pension fund and the employer will be allowed to agree to a 70/30 split.
The new approach will only allow the VAT on pension fund investment management services to be deductible where:
- the services were supplied to the employer (whether the employer commissioned and paid for the services will be relevant, although not exclusively, according to HMRC's announcement)
- the employer must establish a direct and immediate link between the supply received and the taxable supplies that the employer makes and
- there will have to be a combined supply of both investment management and pension administration services for the investment management services to be VAT deductible.
As regards the need for a direct and immediate link between the supply received and the taxable supplies that the employer makes, HMRC's announcement contains the somewhat opaque comment that the services received should 'go further than the management of the investments', in order for them to be classed as general costs (and therefore VAT deductible).
Where the employer receives the services but the pension fund bears the cost (by way of reimbursement or a set-off against pension contributions), HMRC says that it will require an equivalent amount of output VAT in respect of the amounts reimbursed to be accounted for (this would potentially be deductible by the trustees).
What did the PPG ruling say?
PPG's pension funds were separate from PPG, both legally and fiscally. One of PPG's subsidiaries entered into contracts with the suppliers of services relating to the administration of the pensions and the management of the pension fund assets. The subsidiary paid the costs and did not pass those costs on to the pension fund.
The CJEU said that there had to be either a direct and immediate link between a particular input transaction and an output transaction or, where the costs of the services were part of the employer's general costs and were 'components of the price of the goods or services he supplies' then those costs would have a direct and immediate link with the employer's economic activity.
By setting up the pension fund, PPG complied with a legal obligation imposed on it as an employer and, insofar as the costs of the services formed part of its general costs (which the CJEU said was for the referring court to verify) then those service costs were part of PPG's 'economic activities' and there was therefore a direct and immediate link.
As the court decided that the VAT was deductible, it did not go on to look at the exemption question that had been raised (and disposed of) in the earlier 'Wheels' decision.
What was the earlier Wheels decision about?
The European Court ruling in respect of the Wheels Common Investment Fund decided that occupational pension schemes should not be exempt from the requirement to pay VAT on fees charged by third parties. This issue is relevant to pension funds with segregated investments managed by asset managers (investment management via pooled funds or insurance wrappers is already exempt). The proceedings were prompted by the fact that investment trust companies were granted this exemption following another European Court ruling a few years ago.
The employer in the PPG case asked whether the 'special investment fund' exemption examined in Wheels was available in this case but the ECJ felt that that question did not need to be considered because it had decided that the VAT was deductible (the court also acknowledged that the scope of the exemption had already been examined in Wheels anyway).
What does the HMRC announcement mean for employers?
It is important to note that HMRC's announcement relates to defined benefit pension schemes (the announcement notes that a CJEU ruling regarding defined contribution schemes is expected soon).
Employers have not tended to pay for the investment management costs relating to their pension schemes since HMRC's stance has been that those costs would not be VAT deductible for the employer. HMRC's reaction to the PPG decision has, nevertheless, been keenly awaited.
As regards past practice, HMRC says that it will not take any action to correct the position where the employer has deducted a proportion of the VAT under the previous rules without meeting the criteria under the new rules.
For those businesses interested in claiming a refund of any input VAT not previously claimed, any earlier 70/30 split would need to be recalculated. Claims for repayment will be subject to the usual four-year capping rules so the claim can relate to the four-year period ending with the date of the claim.
HMRC's requirements for making a claim are outlined in its announcement:
'Any claim made must set out the basis of the error and the amount being claimed and show how that amount has been calculated. The claim should also make it clear whether the claim is in relation to VAT incurred in relation to a defined benefit or a defined contribution pension scheme. The claimant must be able to provide copies of the documentation used in the calculation of the claim on request. An estimated claim, or a declared intention to lodge a claim at a future date, will not stop the clock running on the four year cap.'
However, there are several unanswered questions about which we will be contacting HMRC.
For instance, will the requirement for a direct and immediate link between the supply received and the taxable supplies that the employer makes, now imposed by HMRC in relation to investment services, need to be proved for non-investment services too? We would hope that that would not be the case because HMRC's historic reasoning for allowing scheme day-to-day management costs to be VAT deductible for the employer has been on the basis that such costs are overheads of the employer and therefore have a direct and immediate link to its business (this is reiterated in the announcement, albeit under the heading describing HMRC previous policy).
As highlighted above, it is unclear what exactly is meant by the requirement for the services received to 'go further than the management of the investments', in order for the costs of those services to be considered general costs (and therefore VAT deductible). This would suggest that only that portion of the services would be VAT deductible but the announcement is not clear on this point. Allied to this is HMRC's past practice of listing services that it classed as investment management services (such as brokerage charges and professional trustee services) which were not, therefore, VAT deductible. What is the status of that list now and, if it survives, how would it fit into the new VAT jigsaw?