Summary of issues
Recent changes have been announced by HMRC regarding VAT and the administration and management of pension funds. Currently the issues for BD and DC schemes are different as can be summarised as follows.
Defined Benefit schemes
Previously HMRC allowed employers to recover the VAT cost of administration of the scheme (subject to invoices being addressed to it and it being able to recover VAT normally). Detailed at the end of this briefing is what HMRC regarded as administration. If these costs were reimbursed by the Trustees of the scheme the employer did not have to charge VAT. VAT incurred on costs in respect of the fund investments could not be recovered by the employer as HMRC took the view that these costs were proper to the fund. If the employer paid for these costs and was reimbursed by the Trustees this was a supply for VAT purposes and VAT was required to be charged. Normally such VAT would be a cost to the fund. What HMRC defines as investment costs is detailed below.
Often a fund manager would provide both administration and investment costs and where these services were included in the same invoice, HMRC normally allowed an employer to recover 30 per cent of such fees as being related to administration.
What has changed?
HMRC now accept that VAT incurred on both the administration and investment costs are potentially costs that can be recovered by the employer. However, this is subject to there being tripartite agreements in place between the service provider, the fund and the employer. The specific conditions that have been detailed by HMRC are set out further below.
Potentially this is good news as VAT that was previously a cost to the scheme may now be recovered. However, it is not straightforward as the following points need to be carefully considered.
1. Where a fund manager provides both administration and investment costs HMRC will no longer allow an employer to recover 30 per cent (from 1 January 2016) of such fees as being related to administration purely by having an invoice made out to it. Now (again from 1 January 2016) the employer will need to be a party to the contractual position to recover VAT on either the administration and investment costs. This is the tripartite agreements mentioned above and the conditions stipulated by HMRC for these agreements are as follows.
- An employer may therefore be able to deduct VAT incurred on these services in line with its residual recovery position where, as a minimum, the contract with the service provider evidences that:
- the service provider makes its supplies to the employer (albeit that the contract may recognise that, in the particular regulatory context in which DB schemes operate, the service provider may be appointed by, or on behalf of, the pension scheme trustees);
- the employer directly pays for the services that are supplied under the contract;
- the service provider will pursue the employer for payment and only in circumstances where the employer is unlikely to pay (for example, because it has gone into administration) will it recover its fees from the scheme’s funds or the pension scheme trustees;
- both the employer and the pension scheme trustees are entitled to seek legal redress in the event of breach of contract, albeit that the liability of the service provider need not be any greater than if the contract were with the pension scheme trustees alone and any restitution, indemnity or settlement payments for which the service provider becomes liable may be payable in whole to the pension scheme trustees for the benefit of the pension scheme (for example in circumstance where the scheme is not fully funded);
- the service provider will provide fund performance reports to the employer on request (subject to the pension scheme trustees being able to stipulate that reports are withheld, for example where there could be a conflict of interest); and
- the employer is entitled to terminate the contract, although that may be subject to a condition that they should not do so without the pension scheme trustees prior written consent (this can be in addition to any right that the pension scheme trustees may have to terminate the contract unilaterally).
In addition to the above, evidence that the pension scheme trustees agree that it is the employer who is entitled to deduct any VAT incurred on the services will reduce the potential for disputes.
As a result discussions will need to take place with suppliers of fund investment services or providers of both administration and investment costs to see if they are prepared to meet these conditions. For suppliers of administration services or suppliers that can separate out (if needed) the administration services it should be possible for the supplier to contract directly with the employer without the need for tripartite agreements.
2. If the employer meets the conditions to enable it to recover VAT on administration costs or both administration and investment costs then; if these costs are specifically recharged to the fund VAT will need to be charged to the fund and that VAT is expected to be a cost to the fund. There is a current lack of clarity here as HMRC have said ‘specifically recharged’ and have indicated that if a fund calculated its contribution needs from the employer in light of its new cost base ie without it bearing administration and or investment costs then this would not represent a specific recharge. This would be the optimal VAT position as the employer would be able to recover more VAT (on the investment costs) and not have to pass this VAT cost onto the fund. The challenge will be to get to this position.
3. However, before doing so it is sensible to seek to identify how much VAT is at stake. We would therefore recommend that you contact fund managers to seek to identify what VAT has been charged. This is not straightforward however; as potentially money may have been invested in funds such as Authorised Units Trusts, OEICs where the investment management costs would have already been exempt from VAT in their own right. In addition, fund managers often did not split out VAT (if charged) as there was previously no need to do so.
Next steps for Defined Benefit schemes
- Confirm the current treatment of administration and investment costs incurred by both the employer and the fund to ensure that VAT has been correctly accounted for in the past. This is particularly to confirm that the employer has not recharged investment costs (see below for definition) to the fund without charging VAT.
- Seek confirmation from service providers to identify what VAT has been incurred by the fund on investment management and related services.
- Given the opportunity to restructure arrangements to enhance the VAT recovery position, we would recommend that the fund and employer give consideration to the tripartite conditions and, where appropriate, contact the service provider(s) to agree which costs should be contracted directly from suppliers by the employer, and which costs should be subject to these tripartite agreements (subject to the supplier agreeing). The earlier these discussions start the better, as whilst 2016 seems a long time into the future, time has a habit of passing quickly.
- As to ongoing employer contributions to the fund, the employer and the fund should begin financial modelling to determine what costs should be incurred by each party, and the subsequent overall effect on the contributions required by the fund.
Defined contribution schemes
Previously HMRC believed that the investment costs of a DC scheme should be subject to VAT. However, following the recent European Court judgement in the case of ATP HMRC now accept that such costs should be VAT exempt. This change only impacts DC schemes - not DB schemes.
As a result of HMRC’s subsequent change in policy, the DC fund potentially has the opportunity to reclaim (for the fund) any VAT charged on such costs for the last four years, and eradicate VAT going forward.
Next steps for defined contribution schemes
- Seek confirmation from service providers to identify what VAT has been incurred by the fund on investment management services.
- If VAT has been incurred in the last four years in respect of such costs, a refund should be sought from the providers.
Other than as noted, no further action is currently required although HMRC have indicated that it is considering further changes similar to the tripartite agreements for DB schemes. However, no announcements are expected until the summer/autumn.
What did HMRC previously regard as employer costs, and what constituted investment services and consequently costs of the fund?
HMRC gave the following examples of expenses on which input tax may be reclaimed.
- Making of arrangements for setting up the pension fund.
- Management of the scheme (ie collection of contributions and payment of pensions).
- Advice on a review of the scheme and implementing any changes.
- Accountancy and audit services relating to the management of the scheme (eg preparation of annual accounts).
- Actuarial valuations of the assets of the fund.
- Actuarial advice in connection with the fund's administration.
- Providing general statistics in connection with the performance of the fund's investments, properties, etc.
- Legal instructions and general legal advice including drafting of Trust deeds insofar as they relate to the management of the scheme.
- HMRC gave the following examples of expenses on which input tax may not be reclaimed.
- Advice in connection with making investments.
- Brokerage charges.
- Rent and service charge collection for property holdings.
- Producing records and accounts in connection with property purchases, lettings and. disposals, investments, etc.
- Trustees' services (ie services of a professional trustee in managing the assets of the fund).
- Legal fees paid on behalf of representative beneficiaries in connection with changes in pension fund arrangements.
- Custodian charges.
If you require further assistance, please contact Ian Carpenter or the RSM VAT team.