VAT on professional fees

Introduction

The recoverability of VAT on professional fees paid in respect of occupational pension schemes has been in the spotlight recently.

Following two CJEU cases, HMRC issued two Briefs revising its original position on VAT and pension schemes.  These were subsequently withdrawn.  Please see our June 2014 Alert for details.

On 25 November 2014, HMRC published:

• Brief 43 (2014): VAT on pension fund management costs which confirms when an employer may deduct the VAT that is charged on services provided in relation to pension schemes.
• Brief 44 (2014): VAT treatment of pension fund management services which explains the circumstances where VAT is not chargeable on such services.

In this Alert:

• Key points
• Recent CJEU cases
• Position pre-2014
• Investment management fees for some DC schemes
• Administration fees
• Transitional provisions
• Action required?

Key points

• Historically, HMRC allowed employers to recover VAT on invoices for professional fees addressed to (and paid by) the trustees in relation to the administration of the scheme.
• By contrast, HMRC has not previously allowed employers to recover VAT on investment management fees in the same way except to the extent such fees were covered by mixed invoices.
• Following two recent CJEU cases earlier in 2014, HMRC issued two Briefs concerning VAT on administration and investment management fees. These were withdrawn in June 2014.
• HMRC has now issued two further Briefs, Brief 43/14 and Brief 44/14. HMRC now accepts it may be possible for an employer to recover VAT on administration fees provided certain conditions are met. Fees in relation to investment fees may be exempt.

Recent CJEU cases

• In the July 2013 decision in PPG Holdings BV, the CJEU ruled that an employer with a DB pension scheme is, as a taxable person, entitled to deduct the VAT paid on services relating to the management and operation of a pension fund set up for employees and former employees (both day-to-day management costs and investment management fees). The court confirmed that input tax recovery is permitted where there is a “direct and immediate link” between the cost of these services and the employer’s economic activity as a whole.
• In March 2014, in ATP PensionService, the CJEU concluded that a DC scheme could be a “special investment fund”, if certain conditions are met. Although it is for the Member States to define “special investment funds” (SIFs), the CJEU stated that: “The essential characteristic of a special investment fund is the pooling of assets of several beneficiaries, enabling the risk to be borne by those beneficiaries to be spread over a range of securities.”  HMRC have now confirmed that a typical UK DC scheme (either trust- or contract-based) meets this definition and also the fees for “management of special investment trusts” are consequently exempt from VAT.

Position pre-2014

• In the past, HMRC has allowed employers to recover VAT on invoices for general administration fees for work commissioned by and delivered to the trustees of UK occupational pension schemes under Notice 700/17.
• By contrast, investment management fees were generally not recoverable, except to the extent that these costs were included on a mixed invoice (containing administration and investment management fees).  Where a mixed invoice was delivered, HMRC “by way of simplification” allowed employers to recover 30% of the VAT as administration fees.  The remaining 70% was treated as referable to investment management costs and was not recoverable by the employer.

Investment management fees for some DC schemes

In the past, HMRC did not consider pension funds of any kind to be SIFs and therefore treated services provided in connection with all types of pension fund as falling outside the VAT exemption for fund management services.

In light of the CJEU’s judgment in the ATP case, HMRC now accepts that UK DC pension funds that have all of the certain key characteristics are SIFs for the purposes of the fund management exemption. These characteristics are:

• they are solely funded (whether directly or indirectly) by persons to whom the retirement benefit is to be paid (ie the pension customers)
• the pension customers bear the investment risk
• the fund contains the pooled contributions of several pension customers
• the risk borne by the pension customers is spread over a range of securities.

This means the services of managing and administering those funds should be, and always should have been, exempt from VAT. But HMRC makes it clear that “only fund management and administration services that are integral (ie specific and essential) to the operation of a pension fund will qualify for exemption”. HMRC gives the example of supervisory services which it considers does not meet this test.

Where investment management or administration services are supplied to a scheme that has a number of funds, some that possess the characteristics of a SIF and others that do not, to determine the correct VAT treatment of the services in question it will be necessary to apply the rules on single / multiple supplies outlined in HMRC guidance manual, Supply and consideration.

UK legislation will be amended in due course to implement the CJEU judgment.  In the meantime, HMRC have said that taxpayers may rely directly on EU law to exempt pension fund management or administration services in accordance with the policy outlined in HMRC’s Brief. HMRC is still considering whether the judgment could have wider application and guidance will be issued if there are to be any further changes.

VAT which has been paid but should have been exempted may be recovered, subject to specific time limits.

Administration fees

Under Notice 700/17, HMRC allowed the employer to recover VAT on administration fees paid by pension scheme trustees on the basis that these costs were the costs of the employer in running the scheme, and therefore a legitimate expense of the employer.

HMRC Brief 06/14 withdrew Notice 700/17 and stated that HMRC was changing its policy for DB schemes as a result of the PPG case.  Consequently, it appeared that VAT on invoices for professional fees in relation to DB schemes that are addressed to (and paid by) the trustees, would not be recoverable by the employer.  VAT may, of course, be recoverable by the trustees but, in our experience, not many trustees are registered for VAT.

In Brief 43, HMRC sets out its interpretation of the legal position.  HMRC’s view is that the employer may now recover input tax in relation to the management of its pension scheme only if it:

• is the recipient of the supply
• is a party to the contract for those services, and
• has paid for them.

In particular, HMRC states in Brief 43 that to meet this test: “A fundamental criterion to be considered is economic reality and the most useful starting point is to examine the agreements between the parties.”  This can be demonstrated by “contemporaneous evidence that the services are provided to the employer and, in particular, the employer is a party to the contract for those services and has paid for them”.

Transitional provisions

HMRC now accepts that there are no grounds to differentiate between the administration of a pension scheme and the management of its assets.  This means there is no longer a need for any administrative simplification to deal with supplies involving both elements.  In each case, the employer will potentially be able to deduct input tax if it receives the supply of services.

A transitional period will operate until 31 December 2015.  Until the end of this period, where the pension scheme receives the services, the pension scheme and the employer may continue to agree to a 70/30 split on the terms set out in Notice 700/17.  It seems likely that this transitional period will not apply to invoices which are not mixed invoices.  The transitional provisions are unclear from the Brief so we have requested confirmation from HMRC but have not had this yet.

Action required?

• Scheme sponsors should discuss future arrangements for VAT on pension scheme administration and investment management fees with their tax advisers.
• For DB administration fees, HMRC does not intend to take any action to “correct the position”, if an employer has in the past recovered VAT that it would not now be entitled under the new criteria set out in Brief 43.
• For DC management fees, businesses that have accounted for VAT on pension fund management services which now qualify for exemption may claim a refund. However, claims will not be considered for periods ending more than 4 years before the date on which the claim is made.
• Notice 700/17 which covered this issue has been withdrawn. We are expecting a revised Notice 700/17 shortly which may contain further information.

If you wish to discuss any of these issues, please ask your usual Sackers’ contact.