Decoding HMRC's reading of the VAT verdict

In short, it is good news for trustees and sponsoring employers of defined contribution schemes, who should no longer pay VAT on certain services and who are able to recover some historic VAT. 

It is disappointing news, however, for employers of defined benefit schemes whose VAT recovery is likely to be worse than before. Of course, it is not quite as simple as that.

HMRC had allowed sponsoring employers to recover VAT on administration services but not on investment management services. 

Where services straddled both they allowed a split of 70/30 – where 30 per cent was attributed to administration, on which VAT could be recovered by the employer.

The court's decisions in the cases of PPG and ATP prompted HMRC to rethink its position. 

No such concession has been stated for administration-only services, which means DB scheme employers may have to act fast

DB schemes

Following the PPG judgment, HMRC now accepts there are no grounds to differentiate between administration and investment services, meaning VAT on both is potentially recoverable by the employer. 

This, in itself, is good news. However, in order for the employer to recover VAT it must be the recipient of the services and, in particular, be a party to the contract and pay for the services.

This requirement poses a real problem for occupational pension schemes because typically the trustees contract and pay for the services. 

Also, although this happened to be the scenario in the PPG case, it is arguable the ECJ did not intend the case to be interpreted so narrowly.

Trustees and employers may be able to change their legal arrangements to bring themselves within the new policy. Alternatively, trustees could be made part of the employer's VAT group.  

In either case, care will be needed to ensure that any changes are consistent with the trustees' legal duties. If steps are not taken, VAT recovery will be worse than before.

There is a 12-month transitional period, but the extent of its scope is unclear. HMRC states that the 70/30 split for combined administration and investment invoices may continue up to December 31 2015. 

Strangely, however, no such concession has been stated for administration-only services, which means DB scheme employers may have to act fast.

DC schemes

HMRC has followed the decision in ATP and now accepts DC schemes are exempt from paying VAT on investment management services and, potentially, some administration services. 

This is on the basis that pension funds that have the following characteristics are ‘special investment funds’, the management of which is exempt from VAT under EU law:

• They are solely funded, directly or indirectly, by the members;

• The member bears the investment risk;

• The fund contains the pooled contributions of several members; and

• The risk borne by the members is spread over a range of securities.

In practice this means most DC schemes should be eligible for exemption and VAT should not be charged on certain services – but it is not entirely clear what services are covered by the exemption.  

HMRC states that, as well as investment management and fund administration services, the exemption applies to administration services that are integral to the operation of the pension fund.

Trustees of DC schemes may reclaim VAT they have historically overpaid in the four years previous. Generally the supplier, eg investment manager, should reclaim the overpaid VAT from HMRC and refund this to the trustees. 

If the investment manager is not able to recover all the overpaid VAT, because of offsets that HMRC will apply, trustees may take court action to recover the difference direct from HMRC. 

If trustees have used overseas investment managers, they will need to claim overpaid VAT direct from HMRC. 

HMRC said it is still considering whether the ATP judgment could have wider implication and further guidance may be issued. 

It also intends to update its historic guidance to reflect the recent policy changes, which will perhaps shed some light on the areas of uncertainty. 

Katharine Howe is an associate at law firm Hogan Lovells