HMRC has been wrangling with a recent EU judgement saying DB schemes could reclaim VAT. With Brexit on the horizon, James Phillips explores whether the attempt is futile
When the Court of Justice of the European Union (CJEU) ruled defined benefit (DB) schemes could reclaim value-added tax (VAT) on investment management expenses, UK trustees breathed a sigh of relief.
In the 2013 PPG Holdings case, the CJEU ruled an employer that had set up a pension fund for its employees could reclaim VAT incurred while paying for services to manage and operate that fund.
But the relief was short-lived as HM Revenue and Customs (HMRC) immediately shut the door, arguing the ruling applied only where sponsoring employers run the scheme, whereas in the UK trustees are in charge.
Three years on, the department is still considering how best to comply and is consulting on the best methods for schemes to reclaim the tax.
It is due to issue guidance on the issue imminently, but with Brexit in the pipeline, will the EU ruling apply to the UK in two years' time?
The judgment has left industry and the government scratching their heads on how to comply.
The principle reason for the confusion is the ruling was based on the Dutch pension system, where employers run the pension scheme, whereas in the UK regulation requires trustees to be in control.
Trustees can currently send a mixed invoice for administrative and investment management expenses to the sponsoring employer, but only a maximum of 30% can be reclaimed by the sponsoring employer.
HMRC does not want to hinder schemes' ability to reclaim VAT on investment management expenses, but the current legal framework makes it impossible.
Eversheds partner Steven Hull explains this does not mean schemes cannot reclaim VAT, but the buck lies with trustees.
He says: "Initially, this was hailed as a real breakthrough because the thought was UK employers could recover VAT on investment arrangements. However, HMRC said you can't unless the employer is party to the agreements, but there are UK laws preventing that.
"Trustees have to enter into investment arrangements, as well as auditing and legal services, so we have an immediate problem in the UK."
Pinsent Masons partner Darren Mellor-Clark thinks that current methods have a low VAT recovery rate.
He says: "The PPG decision said, in the right circumstances, the employer can recover the VAT, which would eliminate an awful lot of VAT costs on DB schemes.
"HMRC's policy has been investment management costs belong to the trustees and the scheme itself, with a lower recovery rate of 5%-30%. If the employers could recover VAT, they would be able to recover it all."
However, Hull adds that some attempts may prove futile due to an inability to reclaim corporation tax. HMRC's view is where the employer pays directly for investment management costs, they would not be entitled to a corporation tax reduction.
"Return on investments is regarded as consolidated income expenditure and you can't recover corporation tax on that," he says. "While VAT and corporation tax are the same at 20%, it's pointless trying to recover it, because what you gain from VAT you'll just lose on corporation tax."
Consequently, trustees and sponsoring employers are investigating how they can make the court ruling work for their schemes.
Hull says three options are available to them: some more complex than others.
They can opt for tripartite agreements, where the sponsoring employer is written into existing contracts with asset managers and other service providers such as administrators. The sponsoring employer then pays directly for the contracted services and can reclaim the VAT.
Alternatively, the employer and the trustees can enter into a new contract between the trustee board and the employer. This is where the employer agrees to pay the trustees for the costs they incur from third-party providers to carry out delegated services on their behalf: known as a ‘back-to-back' agreement. In this arrangement, the trustee board would then submit a VAT invoice to the employer for any charges the trustees have incurred.
Another option, where the scheme trustee is a corporate trustee, is for the trustee to join the same VAT group as the company. The input VAT of the corporate trustee on invoices from third-party service providers would then be reclaimed by the entity appointed to recover VAT on behalf of all the entities in the VAT group.
Hull says: "The ‘back-to-back' arrangement has the greatest chance of recovering the most amount of VAT, alongside tripartite.
"HRMC really like the back-to-back arrangement. The trustees merely submit a bill to the employer and there are no contractual changes."
However, he adds trustees should undertake a cost benefit analysis of each possible option before making any moves to reclaim the tax.
He says: "Analyse first the VAT you realistically think you will be able to recover. You will need to do that for each of the options available to you. Is it worth the hassle?
"All these options require further clarification from HMRC before they can realistically be considered."
Sooner rather than later
When the advice is issued, schemes should begin preparing for the 1 January 2017 implementation date immediately. With Brexit looming, the timeframe for reclaiming VAT may be fairly short.
Mellor-Clark warns any schemes hoping to get VAT back from HMRC should file their claims as soon as possible.
"Brexit could have a significant impact on reclaiming historic VAT. If schemes don't bring that challenge before the UK leaves the EU, then the opportunity to get retrospective claims could go forever. Once we've left, the ability to rely on this EU law is dramatically reduced."
With uncertainty over when Article 50 will be triggered and how quickly the negotiations will be completed, Mellor-Clark recommends submitting claims as soon as possible.
But Hull argues only with court action can trustees reclaim historic VAT, as HMRC is opposed to it. Even VAT lost during the extended implementation schedule cannot be reclaimed as the industry had asked for the extension.
He says: "HMRC is very clear the world as it will be from 1 January will not help trustees at all in recovering past VAT. What they want to do is draw a bright line between the past and the future.
"The original implementation date was 1 January this year, but the industry said they wouldn't be able to comply with it by then: pension schemes don't move that quickly. So, HMRC extended the deadline to January. Now they would have a strong defence to say: ‘The industry told us to slow down here.'"
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