Little "additional clarity" in HMRC guidance on recovery of DB pensions investment management input tax, says expert

The briefing note sets out HMRC's position in relation to a recent decision by the EU's highest court on the VAT treatment of investment management costs. In July, the Court of Justice of the European Union (CJEU) ruled that an employer was entitled to recover VAT it paid on investment management costs, providing that it did not pass these costs on to the pension fund. Historically, HMRC allowed employers to recover VAT on costs relating to administration, while treating VAT on investment management fees as recoverable only by the pension fund itself.

Financial services VAT expert Darren Mellor-Clark of Pinsent Masons, the law firm behind Out-Law.com said that HMRC appeared to have "posed as many questions as it could have taken the opportunity to answer" in its briefing note. The department appeared to have "taken a very narrow view" of the judgment and ruled that "investment management services are concerned solely with the investment transactions undertaken by the pension scheme", he said.

"The casual observer might be forgiven for thinking that HMRC had chosen to ignore the judgment almost completely," he said. "Aside from the abolition of the 70/30 split it is difficult to see that the brief has changed anything. HMRC still, it would appear, holds that investment management costs belong to the scheme itself. Although not explicitly stated, it would appear that administration costs, in HMRC's view, still belong to the employer. Finally, input tax in relation to mixed supplies of investment management and administration may be recovered by the employer - without using the 70/30 split."

"HMRC's view is that specific investment management costs will have a direct and immediate link to supplies concerning the scheme's investments themselves, as opposed to the employer's business, and will thus not be recoverable by the employer – but where services received 'go further' than management of the investments, then they may form part of the employer's general costs and thus be recoverable. HMRC acknowledges that this may facilitate recovery of input tax where previously it was irrecoverable, but there is no indication of what such circumstances may be," he said.

In its decision last year, the CJEU ruled that Dutch industrial group PPG Holdings BV could recover VAT it paid on investment management costs connected with a defined benefit (DB) pension scheme it operated for its employees. The company bought in services relating to both the administration of the pension scheme and the management of the scheme's assets from a third party, and neither of these costs was passed on to the pension fund. It argued, ultimately successfully, that it should be entitled to recover VAT on these costs because there was, in the words of EU VAT requirements, a 'direct and immediate link' between these costs and its general business.

In the UK, HMRC has traditionally distinguished between costs concerning set up and day to day administration of the scheme and management of the scheme's investments. Input tax on the former was recoverable by the employer, while income tax on the latter was recoverable by the scheme in recognition of the fact that the employer and the pension scheme were legally and financially distinct entities. Where costs for both of these were included on a single invoice, employers could traditionally recover 30% of the VAT charged as related to administration.

In its briefing note, HMRC states that this 70/30 split has been withdrawn with effect from 3 February 2014. There will be a six-month transition period allowing businesses affected by the change to make alternative arrangements, and the note also indicates that HMRC does not intend to take any retrospective action against businesses that used this breakdown before 3 February 2014.

"The brief is clear that with effect from this date, the policy is withdrawn," said financial services VAT expert Darren Mellor-Clark. "However, what is less clear is the position HMRC now expects businesses to follow. It may be implied from the rest of the brief that HMRC expects input tax in relation to investment management services only to be recoverable by the scheme, unless they are also accompanied by some administration. However, the position as regards who should recover input tax in relation to administration is not explicitly made clear."

"Businesses would be prudent to still consider, and perhaps take advice, as to whether they may make additional claims for input tax in relation to investment management costs using the decision in the PPG case. The tone of the brief appears to indicate that HMRC expects a number of such claims to follow. Additionally it would appear that they expect businesses to face difficulty in determining their entitlement. In particular the wording 'an estimated claim, or a declared intention to lodge a claim at a future date, will not stop the clock running on the four year cap' appears to anticipate confusion for businesses to the 'right' thing to do," he said.

HMRC's briefing does not indicate examples of when there will be a "direct and immediate link with taxable supplies of goods or services made by the employer", entitling that employer to a refund on VAT paid. However, it states that where the supplies were not made to the employer, or where the supply is limited to investment management services only, employers will not be entitled to claim. Additionally, where the employer receives the supply but the pension fund bears the cost of the services, HMRC will require an equivalent amount of output VAT in respect of the amounts reimbursed to be accounted for.

"In considering potential claims the brief indicates that businesses meeting the (none too clear) criteria set out are 'entitled but not obliged' to claim a VAT refund," said Mellor-Clark. "This may offer some comfort for those partially exempt businesses for whom the pension scheme enjoys a higher input tax recover rate than the employer."