Corporation tax and income tax: deductibility of pension fund management costs

HMRC’s ‘Revenue and Customs Brief 8 (2015): deduction of VAT on pension fund management costs’ clarified some aspects of HMRC’s position on the VAT treatment of defined benefit scheme management costs borne by the employer under the ‘tripartite agreement’ structure, following the recent ECJ case of Fiscale Eenheid PPG Holdings BV cs te Hoogezand (‘PPG’). However, does the direct tax treatment (corporation tax and income tax for businesses) now need further consideration?

As the reader will be aware if they operate defined benefit pension schemes, the hot topic of recent years has been whether a structure could be put in place to enable the employer to obtain recovery for input VAT on the costs of managing such schemes. Those costs would previously have been borne indirectly (funded out of the company’s contributions, albeit contracted for and paid by the scheme trustees). The pension scheme would have been unable to recover VAT on the costs. However, companies have sought to access VAT recovery by becoming a party to a tripartite agreement with the service provider and the scheme, and by paying the costs directly.

Following a recent European Court of Justice case, HMRC’s position on VAT recovery has become clearer, particularly following publication of the above brief.

However, a secondary issue will be whether the payment is still tax-deductible for the employer for direct tax purposes. A direct contribution to a scheme (out of which the trustees may or may not fund their costs) should be tax-deductible in the normal way in accordance with normal rules, but what about a direct settlement of the trustees’ costs? Might a company be inadvertently putting its direct tax deduction at risk in assisting the trustees to alleviate their VAT irrecoverability?

It appears that, technically, the answer is not entirely obvious. It is generally accepted that payments to pension funds or in creating a pension fund for employees would not be deductible apart from specific legislation (Section 196 Finance Act 2004 - Relief for employers in respect of contributions paid, etc.). However, is a payment of costs to the third party service provider strictly a “contribution paid by the employer under a registered pension scheme”? The legislation does not specifically cater for third-party payments – it does not overtly deal with indirect ‘contributions’ such as where a sponsoring company pays for a service to be provided to the scheme – leaving some uncertainty. This area has not been tested by case law, nor has further guidance been published by HMRC.

If your defined benefit scheme management costs are sizeable, and particularly if you have started entering into the tripartite agreement structure for reasons of VAT recovery, there could be significant direct tax at stake if HMRC did seek to challenge the deductibility. Ultimately, this aspect of such costs may, as with the VAT treatment, also be a matter for a lengthy Court process.

We watch this space with interest.