UPDATE - On 5 September 2016, HMRC extended the transitional period for a further 12 months until 31 December 2017. HMRC also indicated that it may extend that period again. The text of the article below is as originally published in June 2016 and should be read with this update in mind.
The endless saga of the extent to which VAT should be charged, and recovered, in relation to services provided to pension schemes continues to run. There is now less than six months until the transitional period, during which schemes and employers can continue to rely on the old HMRC guidance, expires on 31 December 2016.
Schemes and employers should, therefore, now be engaging with their advisers to ensure that they are set up to minimise any unnecessary VAT exposure and do not continue with practices that may become non-compliant.
This analysis serves as a reminder of the issues, and an update covering the period up to the latest HMRC publication on this topic, which was in October 2015 (Revenue and Customs Brief 17/15) and which, not for the first time, has left schemes and employers with unanswered questions and unsure of what to do next.
Further HMRC guidance is expected in the coming weeks and months, although it may well be that this does not advance the debate much. Taxpayers may simply need to make the best of the situation as communicated by HMRC to date.
What was this all about again?
As a reminder, the current issues stem from the fact that two court cases (ATP and PPG) fundamentally changed the way in which HMRC traditionally treated VAT on pension scheme costs:
- It was established in ATP that defined contribution schemes are "special investment funds" and therefore exempt from VAT, which HMRC previously did not accept was the case.
- For other schemes, the traditional HMRC view that VAT on management/administration costs was recoverable by an employer, but VAT on investment costs was not, is no longer a valid distinction, following the PPG case. However, HMRC sought to limit the damage by tightening up its requirement for there to be a clear supply of services to the employer (as opposed to the trustees) if VAT was to be recoverable by the employer.
See our earlier alerts for further background detail.
Defined contribution (DC) schemes
It is likely that DC schemes will have paid VAT which they need not have done. There is a four-year limitation period for claims to recover such overpaid VAT. DC schemes and employers should therefore be urgently discussing the possibility of protective claims, before any overpaid VAT recovery becomes time-barred.
Previously it had been thought that HMRC would adopt a narrow interpretation of which services were covered by the relevant court judgment, but that does not appear to be the case at present.
Schemes should also ensure that they are not wrongly charged VAT in respect of future invoices.
Services becoming VAT exempt is also likely to affect pricing (as input tax cannot be recovered by suppliers on exempt services). This will therefore form part of contract discussions between schemes and their suppliers.
Defined benefit (DB) schemes
The difficulty these schemes and employers face is the need to satisfy HMRC's requirement that if the employer is to recover the VAT, it must have been a recipient of the supply of services.
However, of the various solutions mooted, three have gained traction. None of them is perfect. We set them out below, and encourage trustees and employers to engage with their advisers before the transitional period expires to determine what the best approach for their particular circumstances may be.
1. Bring the trustees within the employer's VAT group.
The basic idea of a VAT group is that for companies within the same corporate group, a single "representative member" can recover the VAT incurred by all members of the group. There appears to be no reason not to extend this to the corporate trustee of a pension scheme, and it avoids the need to make the employer a direct recipient of the supply of services.
The concern with this for pension scheme has historically been the fact that members of a VAT group are jointly and severally liable for one another's VAT liabilities. It is obviously unacceptable for pension scheme trustees to be on the hook for an employer's VAT, or that of its other group companies.
However, there have been reassuring words from HMRC that they would not see assets subject to a trust (such as pension scheme assets) as being available to them for this purpose.
2. Trustees provide pension scheme management services to the employer
The idea with this is that trustees would register for VAT, and provide a taxable supply to the employer, the supply being the management of the employer's pension scheme. This would enable trustees to recover their VAT costs in their own right.
There are two disadvantages to that, however:
- Such a contract is somewhat artificial, given that the trustees would probably not be doing much more than they were required to do under their trustee duties anyway, and it would need to be carefully drafted to avoid causing a conflict with the trustees' duty to members.
- Even if that can be overcome (which it probably can), HMRC are saying that with this solution, only VAT on management/administration services, not investment, would be recoverable - in other words, we would have come full circle to the position before the PPG case!
3. Tripartite contracts
It is possible to set up a tripartite contract between the employer, the trustees and the supplier, making clear that the employer is responsible for paying the supplier's fees, and has limited rights in return, but the main beneficiary of the supplier's work remains the trustees.
There would clearly be a burden involved in drafting such contracts, and potential difficulties in relation to the professional conduct rules on professional advisers.
The main weakness with this solution is that if an employer pays a supplier directly under a tripartite contract, the VAT would be recoverable (if the terms of the contract were properly set up) but the employer would no longer be able to deduct the payment for corporation tax purposes, on HMRC's reading of the Finance Act 2004.
HMRC's last October briefing stated that it was still considering representations, in particular in relation to asset management services and whether there are alternative tripartite agreements that would enable a Corporation Tax deduction, but as yet the promised guidance has not been forthcoming.
There are downsides to all the above solutions, but there is also a downside to doing nothing, namely that the employer and trustees might either (a) miss out on the opportunity to recover VAT, or (b) continue with a VAT practice that will be judged by HMRC as unlawful.
We therefore recommend that schemes and employers continue to monitor for developments, but proactively engage with tax and legal advisers between now and the end of the year to ensure that they are well-placed to adopt a compliant and tax-efficient structure for the supply of services to the pension scheme from 1 January 2017.