No VAT Exemption for Workplace Pensions

Introduction

The European Court has rejected a claim that workplace DB pension schemes in the UK should be exempt from paying VAT on investment management services.

In this Alert:

• Key points
• Background
• Appeal to the First Tier Tribunal (Tax Chamber)
• The European Court ruling
• What happens next?

Key points

• DB pension schemes and common investment funds cannot benefit from the VAT exemption available to other funds that constitute “special investment funds”, as they can be distinguished on a number of grounds.
• As a result of the ruling, pension schemes will continue to pay around £100 million per year in VAT and will be unable to make backdated claims that might have totalled £2 billion.1

Background

Wheels Common Investment Fund (Wheels) is the trustee of a fund which pools, for investment purposes, the assets of workplace pension schemes established by the Ford Motor Company. Fund management services were provided to Wheels by Capital International Limited (Capital), on which VAT was charged and accounted for to HMRC.

Under a European Directive,2 the “management of special investment funds” is exempt from VAT (“the exemption”). In its 2007 decision in Claverhouse,3 the CJEU concluded that, as special investment funds, investment trusts should be exempt from paying VAT on investment management services.4 However, HMRC did not automatically extend the effect of the Claverhouse ruling from investment trusts to pension trusts, being of the view that workplace pension schemes do not come within the exemption and should therefore continue paying the tax.

Following the Claverhouse decision, Capital sought repayment of the VAT paid in respect of the fund management services it had supplied, on the basis that those services came within the exemption. When HMRC rejected the claim by Capital, Wheels appealed and, in 2008, Wheels and the NAPF agreed to bring a joint legal challenge regarding the application of VAT on the investment management services supplied to occupational pension schemes.

Appeal to the First Tier Tribunal (Tax Chamber)

The Tribunal agreed that the services supplied to Wheels were services relating to “management”, within the meaning of the exemption. However, whether the fund held by Wheels should be classified as a “special investment fund” was unclear.

To help it interpret the exemption, in 2011, the Tribunal referred a number of questions to the CJEU for a preliminary ruling, broadly asking whether:

• “special investment funds” can include:

– a typical workplace DB pension scheme, established by an employer, to provide pension benefits to employees; and/or

– a common investment fund in which the assets of several such pension schemes are pooled for investment purposes;

• a Member State is entitled to legislate so as to include collective investment funds in the definition of “special investment funds” but to exclude workplace pensions and common investment funds; and

• an investment fund in which the assets of a retirement pension scheme are pooled, is identical to the funds that constitute “special investment funds” or if it is sufficiently comparable as to be in competition with them.

The European Court ruling

The CJEU held that the exemption does not extend to UK DB schemes.

The CJEU noted that the driver behind the exemption is the need to facilitate investment in securities by means of investment undertakings by excluding the cost of VAT. This serves to ensure that the principle of fiscal neutrality is applied to the common system of VAT in the EU, as regards the choice of direct investment in securities and investment through collective investment funds.

Investment funds in which the assets of a retirement pension scheme are pooled cannot be “collective investment undertakings”5 as they are not open to the public. Instead, they are an employment related benefit, granted by an employer only to its employees.

The court also found that such funds were not “sufficiently comparable” with collective investment funds as to be in competition with them, as there were a number of characteristics which differentiated them.

Key factors in reaching these conclusions were that, unlike private investors in a collective investment fund, in a workplace DB pension scheme:

• members do not bear the risk arising from the management of the investment fund in which the scheme’s assets are pooled;
• members’ pensions do not depend on the value of the scheme’s assets and the performance made by the scheme’s fund managers; and
• even though the employer must bear the financial consequences of the investments made by the pension scheme’s fund managers, its position is not comparable to that of an investor in a collective investment fund because contributions are made to the scheme as a means of complying with the employer’s legal obligations towards its employees.

What happens next?

The case now returns to the Tribunal which will be required to decide, among other things, the parties’ costs.

The NAPF has said that while the decision is “deeply disappointing”, it will continue to lobby the European Commission as it reviews the VAT Directive and to “make strong representations that the management of pension funds should be VAT exempt under the proposed change to the current VAT regime.”

1 Source: NAPF PolicyWatch 8 March 2013
2 The relevant exemption is set out in the Sixth Council Directive 77/388/EEC of 17 May 1977 on the harmonisation of the laws of the Member States relating to turnover taxes – Common system of value-added tax: uniform basis of assessment (now repealed) and Council Directive 2006/112/EC of 28 November 2006, both of which are applicable to the present case
3 JP Morgan Fleming Claverhouse Investment Trust plc; The Association of Investment Trust companies v The Commissioners of HM Revenue & Customs ECJ (Case C-363/05, 28 June 2007)
4 Please see our News: “The ECJ, VAT and Investment Trusts” (July 2007)
5 Within the meaning of Directive 85/611/EEC on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) (as amended)