Defined benefit pension schemes must pay VAT on investment management services says CJEU

In its judgment, the Court of Justice of the European Union (CJEU) said that there were "a number of characteristics" that set DB pension schemes apart from the 'collective investment undertakings' that were able to take advantage of the VAT exception. In particular, schemes were not open to the public and members did not bear the risk arising from the management of the pension scheme funds, it said.

The National Association of Pension Funds (NAPF) said that the ruling prevented pension schemes from claiming backdated VAT worth up to £2 billion from HM Revenue and Customs (HMRC). DB schemes pay about £100 million a year in VAT, according to its figures. The NAPF had challenged HMRC on its position together with Wheels Common Investment Fund (WCIF), the operator of car company Ford's pension schemes.

"This has been a long struggle, and unfortunately the judgment is deeply disappointing," said NAPF chief executive Joanne Segars. "Pension funds were set up to be vehicles that are free from tax, and they should not be paying these VAT charges."

However VAT expert Suzanne McMahon of Pinsent Masons, the law firm behind Out-Law.com, said that the decision had been "somewhat expected" and would provide certainty to fund managers.

"Although expected, the decision is still disappointing for a large number of occupational pension schemes that had submitted claims to HMRC via their fund managers for overpaid VAT and hoped to receive a refund of VAT incorrectly charged over a number of years, had the case been successful," she said. "This would have been welcomed in the current economic climate where many pension schemes are feeling under pressure to meet the liabilities of pension requirements of an increasingly ageing population in the UK."

"However, for fund managers, the certainty that this decision provides means that they can now confirm the VAT treatment of the services they provide to pension schemes and manage both their VAT recovery position and their price structures accordingly to reflect the court's decision," she said.

EU VAT rules exempt "the management of special investment funds as defined by member states" from the tax. In 2008, the CJEU ruled that investment trusts should be included within the definition of "special investment funds". The NAPF and WCIF brought their court action because they believed that pension funds and investment funds had similar characteristics, and that the former should also be included within the scope of the exemption.

The CJEU, considering a referral from the Upper Tier of the Tax Tribunal, disagreed.

"An investment fund in which the assets of a retirement pension scheme are pooled, such as that at issue in the main proceedings, cannot be regarded as a collective investment undertaking," its ruling said. "Such a fund is in fact not open to the public but constitutes, as is clear from the order for reference, an employment-related benefit which employers grant only to their employees."

In addition, the CJEU said that the roles of pension scheme members and employers in relation to the fund differed from the role played by investors in collective investment schemes. DB schemes promise a set level of pension once a member reaches retirement age no matter what happens to the value of the underlying investment. This means that the benefits ultimately received by the scheme member do not depend on the performance of the investments made by the scheme managers. While employers bear the risk of the "financial performance" of investments, their legal obligations towards their employees are met through the contributions they pay into the scheme, the CJEU said.

VAT expert Suzanne McMahon pointed out that the case was not the "end of the story" for pension schemes, as the CJEU was due to hear a case later in the year addressing the VAT treatment of defined contribution (DC) pension schemes. Unlike DB schemes, DC schemes do not guarantee what members will get when they retire. Contributions to the scheme are invested in an agreed way, and the employee can then buy a pension with whatever funds are available on retirement.