As the transitional rules soon come to an end, the compulsory changes to the VAT rules for Pension Schemes are now imminent, as Tom Freeman, Partner & Head of Pensions at Price Bailey explains:
1. Corporate Sponsors with Defined Benefit Pension Schemes, whereby they incur VAT on pension administration and investment management costs.
2. Corporate Sponsors with trust-based pension arrangements where cost recharge arrangements exist between the corporate sponsor and the Pension Scheme i.e. for staff resource, office space, IT equipment or the reimbursement of administration expenses paid on behalf of the Pension Scheme.
What are the key changes?
HMRC issued its first brief on 3 February 2014 announcing changes to the VAT recovery position of employers who pay VAT on services relating to the administration and management of Pension Schemes.
These changes follow the judgment on 18 July 2012 of the Court of Justice of the European Union (CJEU) in the Dutch case: Case C-26/12 PPG Holdings BV (PPG). The Court held that VAT charged on fund management and administration services provided to an employer for the purposes of a legally and fiscally separate pension fund could be reclaimed by the employer (subject to their general VAT reclaim position).
This represents a major change for the UK VAT treatment of pension fund managers’ costs. Until this case, HMRC had not permitted the employer to recover the VAT on investment activity costs, but they generally allowed recovery of the costs associated with the setting up and day to day administration of the pension fund. Where fund managers issued a single VAT invoice for both general management and investment management HMRC has generally allowed the employer to recover 30% of the VAT invoiced.
HMRC has now withdrawn the so called 70/30 split treatment of fund managers’ costs (subject to the application of transitional provisions). In the light of PPG, HMRC has taken a narrow approach, but will accept retrospective claims for VAT where the fund manager’s services for both operational and investment management are supplied to the employer and there is a direct and immediate link to the taxable supplies of the employer. However, this opportunity comes with pitfalls which you will need to discuss with your adviser.
A number of subsequent briefs have been issued by HMRC following consultation with the pensions industry and after receiving representations from a number of Pension Schemes and providers. HMRC has issued more guidance and has confirmed that Schemes can continue to operate under the old rules established in notice 700/17 until 31 December 2016, utilising the ‘transitional provisions’.
What’s the bad news?
More tax payable – In most cases failure to act will increase the costs of running the Pension Scheme. This is because the 30/70 concession on investment management costs will cease to exist and there is now an explicit requirement to demonstrate that the corporate sponsor has a direct and immediate link to the costs of running the Pension Scheme, leading to less VAT on pension costs being recoverable.
Complex structuring – All of the possible remedies (see below) require restructuring of existing processes and arrangements, some more significantly than others. It is therefore important to ensure that this is done in the most pragmatic and cost effective way to avoid incurring significant professional fees. There is no ‘standardised’ solution as Pension Scheme arrangements can differ significantly, so bespoke advice from specialist advisers will generally be required.
Timing – Sufficient time will be needed for planning and implementation. Some of the options will take longer to implement and so we recommend that you start planning as soon as possible. Early implementation could mean saving VAT earlier, so there is an incentive to carry out these changes before the transitional provisions end on the 31 December 2016.
What’s the good news?
Options – There are a number of possible options to best suit the circumstances of your Scheme.
Improved VAT recovery – If structured in the appropriate way, there is the potential to increase the VAT recovery under the new rules, thereby reducing the costs of running the Pension Scheme.
Clarity – Where previously there was some opacity, the new rules provide an opportunity to clarify the VAT treatment for all pension related transactions, providing greater certainty over the VAT that can be recovered.
What options are available?
Three possible approaches to maximising the benefit and mitigating the costs have emerged in the discussions between HMRC and the industry. We think that a combination of these may prove to work best for many organisations:
1. VAT grouping
This option may be suitable if there is a corporate trustee of a Pension Scheme that is eligible to be VAT grouped with the sponsoring employer. However, HMRC is also carrying out a review of the ‘control criteria’ for VAT grouping that could impact on this potential solution. VAT grouping allows costs to be incurred by either member and still be treated as ‘input tax’ of all members.
It also allows re-charging of costs to fellow members without a VAT charge. This allows costs that are related (to both the Scheme and the employer) to be reclaimed in line with the partial exemption rules applicable to the group as a whole. But VAT on costs which specifically relate to supplies made by the Scheme itself, and which are not referable to the wider concerns of the corporate trustee as well, will not be recoverable. It remains to be seen, in individual cases, what the overall impact of this would be.
A major concern often mentioned related to VAT grouping is that the Scheme becomes jointly and severally liable for the VAT debts of the corporate trustee. HMRC has confirmed that its position remains that it is unable to recover VAT from Scheme assets under the statutory provisions concerning joint and several liability of VAT group members, except to the extent that the relevant VAT debt is attributable to the administration and operations of the Pension Scheme itself. However, this should be treated with some caution as this is only stated in HMRC guidance and not statute. HMRC is not bound to follow guidance where it is later found to be wrong.
2. Master Services Agreements (MSA)
As an alternative, Scheme administration services may be provided by the Pension Scheme trustees to the employer(s). Under this arrangement the Scheme buys the services from third parties, and recharges all or part of the cost to the employer, with VAT. The theory is that by creating taxable supplies to the employer, VAT recovery is possible on the underlying cost. The VAT charge is recoverable by the employer, subject to the usual rules on input tax deduction. The VAT registered Pension Scheme is entitled to recover, in full, the VAT which it passes on regarding administration and general Scheme related expenses (including legal, audit or actuarial services), which are used by the trustees to make the onward VATable supply to the employer.
Related reading: “VAT Taxable Supply Basic Definition”
However, HMRC has pointed out that VAT payable on asset management services will not be recoverable in full. This is because the input tax will (or perhaps may) relate to both taxable supplies to the employer and to any VAT exempt supplies made by the Pension Scheme trustees as part of its investment activities. This would therefore only be a partial solution in itself. Consequently, this arrangement coupled with tri-partite agreements (see below) may prove to be the most appropriate remedy.
3. Tri-partite agreements
In Brief 8/2015, HMRC set out that it would allow an employer to recover VAT paid by it as part of a tripartite contract between it, the Pension Scheme trustees of a defined benefit Pension Scheme and a pension fund manager, but similar rules could be adopted for other service providers. That brief sets out detailed guidance as to the form of such a tripartite contract. Some service providers, for example the Scheme actuary and auditor, may refuse to enter a tri-partite contract with the Trustee and Employer as it could be perceived to compromise their independence and create a conflict of interest.
More recently, HMRC has announced that although an employer can recover the VAT payable under such a tripartite contract, in its view direct payment by an employer of asset management costs does not clearly fall within the sponsoring employer’s profit and loss account or contributions to a Pension Scheme and, therefore, will not attract a deductionfor corporation tax purposes. There is a potential remedy to this which HMRC are considering but in the absence of such a remedy this could negate the VAT recoverable from the use of tri-partite agreements.
Pension Schemes and sponsoring employers will welcome the extended transitional period, but time is running out and careful thought will now have to be given as to how best to mitigate the VAT costs of running a Pension Scheme. Although December 2016 is still five months away, it is a short period in which to make key decisions and to start the process of changing procedures and contracts.
It is clear that there is no one easy solution to the VAT and corporation tax issues that have arisen. HMRC has said that it will issue further guidance later this year, which may set out a possible solution to the corporation tax issues. However, HMRC’s clarification could be received too late in the day (or not at all) for action to be taken by those who have not already researched the issues and impacts.
Both the employers and Pension Scheme trustees need to be actively thinking about the VAT which is payable on all costs of running the Pension Scheme and how best to mitigate that VAT. It may be that the options set out above will work for some Pension Schemes; others may need to explore hybrids or other potential solutions.
HMRC has worked hard to mitigate the VAT costs of running a Pension Scheme, but each Pension Scheme and employer will have to think carefully about how it should proceed to ensure that it does not fall into any tax or pensions law traps. In many cases, it may be beneficial to make the changes sooner, rather than to wait until the end of this year when the transitional period ends. Prompt preparation is strongly recommended.