HMRC has issued new guidance on VAT on pension scheme costs. Is it now time for employers and trustees to make a decision?
Employers may need to take action in order to maximise VAT recovery in relation to pension scheme costs. This article outlines the latest developments, sets out the structures that are available to employers and provides next steps for anyone engaging with this issue.
1. HMRC changed its approach following the PPG case
The PPG litigation caused HMRC to change its approach to the VAT treatment of investment services relating to occupational pension schemes.
2. HMRC's transitional period was due to end on 31 December 2017
For a transitional period, employers have been able to rely on the old (pre-PPG) HMRC practice. This transitional period ends on 31 December 2017.
3. HMRC have published new information dealing with certain outstanding points
HMRC's public statements on its post-PPG position have caused much confusion and uncertainty, but new pages published in its internal manual appear to give us as many answers as we are likely to get.
4. Employers should consider how best to maximise VAT recovery
Employers will (it now seems) be able to continue with the pre-PPG arrangements after the end of the transitional period, but if they want to maximise their VAT recovery, they should consider whether any of the other available structures would work better for them.
What was the issue on VAT and defined benefit occupational pension schemes?
In the four years since it was decided, the European court case of PPG has caused uncertainty over employers' ability to recover VAT on investment services relating to occupational pension schemes.
This is particularly an issue for defined benefit pension schemes - defined contribution schemes have been helped by separate litigation which has established that, in most situations, services provided to them are exempt from VAT.
At first, it appeared that the PPG case would result in greater VAT recovery being available, as it established that HMRC's practice of distinguishing between:
- administration (or "management") services (on which VAT is recoverable); and
- investment services (on which it is not)
was not legally justified.
However, HMRC responded by observing that VAT relating to investment services would only be recoverable by employers if they are the recipient of the services (i.e. they need to be a party to the contract between the trustees and the supplier). This raised the prospect of tripartite contracts - i.e. employers being added as a third party to the contracts between trustees and their suppliers.
That, and the series of HMRC briefs on the topic, has caused confusion and uncertainty in the pensions industry. Fortunately, HMRC also allowed a transitional period in which employers could continue to rely on the pre-PPG guidance. Therefore, many employers continue to observe the investment/administration distinction, and the HMRC practice of allowing invoices which combined both to be deemed to be split 70%-30% (iH.e. employers could generally assume that 30% related to administration and recover the VAT on that element).
This transitional period ends on 31 December 2017.
Has HMRC issued updated guidance?
There has been no public announcement, but HMRC has added pages on the topic to its VAT Input Tax manual. This is ostensibly an internal manual for HMRC staff, but, like other such manuals, it is published on the HMRC website and used as much by practitioners as by HMRC itself.
What are the key points in the manual?
There are two key points:
- First, it confirms that HMRC will continue to allow employers to use the existing basis for VAT recovery after 31 December 2017, including the 70%-30% split.
- Second, it confirms our understanding of the other structures that are available for employers who may be able to recover more VAT relating to investment services as a result of PPG.
In summary, those structures are:
- VAT grouping;
- trustees supply services to the employer; and
- tripartite contracts.
Our previous analysis set out more detail on these structures.
The new guidance is available on pages VIT44600 and VIT45400-45510 of the VAT Input Tax manual, which is available online.
What should employers do now?
Employers now have a choice - they can either:
- carry on beyond the end of the year with their current arrangements; or
- change to any of the above structures if that will yield them greater VAT recovery and not cause other difficulties.
Tripartite contracts may not be a suitable solution for most employers, although so far as investment services are concerned, they may be the only route by which employers can recover VAT in full. One of the main issues still seems to be that if an employer pays a supplier directly under a tripartite contract, this may cost them the ability to deduct the payment for corporation tax purposes (because it would no longer count as a contribution to the pension scheme). However, for employers that do wish to use them, the new manual page sets out HMRC's minimum expectations of what the contract needs to cover.
The other structures do not involve tripartite contracts. If the employer operates a VAT group, bringing the trustees within it so that at least some of the trustees' VAT can be recovered is a potentially attractive solution, and avoids the corporation tax risk.
If that solution does not work for a particular employer, the possibility of trustees making a taxable supply of pension management services to the employer, and thereby being able to recover at least some of their own VAT, is also worth exploring.
Which structure to adopt is a question on which employers need to take both tax and legal advice before making any decision. There are pros and cons with each structure, which will require bespoke advice. To maximise VAT recovery, however, it is worth asking the questions now, as we approach the end of the current transitional period.
Note: This analysis relates to defined benefit schemes only. The VAT treatment of defined contribution schemes is different in a number of respects - they are mostly exempt from VAT, if they meet the requirements to be classified as "special investment funds".