IT’s NO SURPRISE that an HM Revenue and Customs (HMRC) amendment to VAT rules may not be as positive as it first seemed.
Last year, the European Court of Justice (ECJ) ruled sponsor employers could recover input tax on investment management and administration costs, following a referral from Dutch firm PPG Holdings BV (Professional Pensions Online, 25 July 2013).
Coming just months after the disappointment of the Wheels test case (Professional Pensions Online, 7 March 2013), which found defined benefit (DB) schemes are not VAT exempt, it seemed fund sponsors had finally caught a tax break.
HMRC joined the Netherlands tax authority in opposing PPG’s claims that employers should be able to recoup 100% of VAT charged against these costs.
The ECJ rejected the arguments, ruling the charges were indeed recoverable as managing a pension scheme in order to provide benefits to employees is a necessary business cost.
Last week, the UK’s tax body amended its policy to reflect the change. But what does it mean in practice for employers and the schemes they back?
A Trojan tax policy
Under previous HMRC rules, employers could recover VAT on administration services, but not investment management services, Eversheds partner and tax expert Giles Salmond explains.
When the services were billed together, VAT recovery was subject to a 70/30 split, with employers being able to claim 30% of input tax, and the fund being entitled to up to 70% depending on the nature of its investments.
The ECJ ruling forced the removal of the 70/30 concession, Salmond says. HMRC has subsequently taken a “very narrow approach” to the PPG result.
Employers can recover VAT “only where they’ve received the services directly”, and only where they have received both services for investment activity and administration, Salmond says.
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The legal structure of UK schemes creates a clear separation between employers and their funds. Salmond predicts few employers will qualify to recover VAT under the PPG ruling due to this distinction. What is more, they can no longer recoup the 30% they previously would have.
Salmond says: “As a result, there is a likelihood the VAT costs for the employer would go up.”
Although the 70/30 policy required services to be invoiced jointly, Salmond says HMRC took a “fairly benign” stance to billing in practice.
However, he suggests the most recent brief indicates the authority – which was the only member state tax body to make representations in the ECJ case alongside the Netherlands – will take “a more restrictive view” towards this.
Employers will likely have to review the contractual relationship with their schemes in order to take advantage of the PPG ruling, Salmond adds.
Norton Rose Fulbright partner Lesley Browning agrees the change in HMRC rules might leave sponsors in a worse VAT position than the 70/30 split.
Under the Pensions Act section 47, trustees are required to appoint all advisers of the scheme, Browning says. However, she argues there may be a “clever way around” the legislation, such as employers and trustees jointly appointing managers.
Browning says: “A lot of schemes are going to have to look at the billing arrangements they have with their manager.
“HMRC is promoting this policy as an improvement in position that meets the criteria handed down in the PPG case, but it may be worse for schemes than the 70/30.”
While the policy itself seems highly prescriptive, Browning says there is some vagueness about what connection a sponsor must have to the services provided in order to recover VAT.
“It’s a shame the revenue doesn’t spell out what it considers ‘a direct and immediate link’ to be,” she says. “It is quite difficult to understand.”
Also, while the 70/30 rule was “a very straightforward mathematical equation”, HMRC’s new position adds further complexity as it may require analysis of what investments in order to claim, as some assets, including property, do not come within the rules, Browning notes.
Some businesses may try to challenge the strict HMRC policy on the basis of the PPG case, which was “quite clear” that VAT could be recovered, she says.
Spending money to save money
While it is clear HMRC has addressed the problem by narrowing its parameters, businesses and pension funds may see some positives if they widen their field of vision.
PwC indirect tax partner Martin Blanche says it may be good news for schemes, in that employers that are able to recover VAT will free up cash for contributions.
He explains: “If an employer pays VAT on investment management and other services for the fund, it’s doing it for business purposes: it needs employees and employees need pensions.
“So if the employer is able to recover the VAT on that basis, the costs of running the scheme are reduced, and therefore theoretically it has more money to contribute back into the fund.”
However, Blanche stresses it remains “a complicated area” for employers and schemes to navigate.
It remains “unclear” how much of the investment management VAT could theoretically be recovered by the employer, given the distinctions HMRC previously held about funds recovering tax.
Blanche says: “If you were doing straightforward investments in the UK, you wouldn’t be able to get the VAT back, but if you were doing opted property or investment outside the European Union (EU) you had an entitlement to recovery.”
Employers must also bear the full costs in order to recover the VAT, Blanche says.
“If the business recharges costs to the fund, either directly or through lower contributions, HMRC says the employer has to charge VAT on those, which leads you back in a circle,” he explains.
In light of these complexities, Norton Rose Fulbright’s Browning argues small employers and their related funds may find it difficult to exploit any benefit.
“For bigger schemes, it’s always worth spending money on trying to find solutions to issues like this. For a small scheme that lacks resource, this is probably bad news,” she says.