Important VAT changes affecting pension funds

Pension funds and VAT: an unwelcome burden for employers

Most occupational pension funds are either not registered for VAT, or do not have a very high VAT recovery rate. Where they then incur irrecoverable VAT, this becomes an economic expense usually borne by the employer. The payment of irrecoverable VAT, such as VAT on investment services which is irrecoverable by the employer, will usually increase the employer’s ultimate pension cost and is just another burden on business.

To add to the problem, HM Revenue and Customs (“HMRC”) have announced in Business Brief 15/05 that they are withdrawing the industry practice of agreeing a general split of fund management charges on a
70/ 30 basis as between the employer and the funds. The original date set was 30 September, but Business Brief 16/05 has now moved this to 1st January 2006.

The 70/30 split

The original reason for this split was to distinguish between investment management, which was a cost proper to the fund itself, and the administration of the scheme, which was a proper expense of the employer. VAT on the latter was therefore deductible at the employers [residual/overhead] recovery rate.

Business Brief 15/05 states that HMRC have now withdrawn the 70 /30 split from use, where:

• employers administer the pension scheme
• the scheme employs specialist pension administrators and separate fund managers for investment.

In these circumstances, third parties providing investment and administration who are able to determine the actual value of each service provided, must provide separate invoices to trustees and employers showing the actual value of the services provided.

Where the third party provider cannot determine the element of investment and the element of administration, HMRC do accept that the 70/30 split can continue, but only if the third party administers the whole or the bulk of the scheme administration.

Action required

Employers and pension trustees should now review their arrangements and procedures in order to limit irrecoverable VAT. If these changes are likely to lead to a higher cost for the employer in providing pension benefits then thought should be given to mitigation of VAT.

Mitigation of VAT: pension funds – the new frontier

CMS Cameron McKenna LLP have been involved at the cutting edge of VAT fund management, for instance in the recent case Abbey National at the ECJ, concerning exemption of depositary and administration charges for collective investment funds. The new VAT “frontier” now addresses:

• VAT Exempt Pension Fund Management (for example if you are a fund manager managing a pension fund incurring irrecoverable VAT)
• VAT Exempt Pension Fund (for example if you are an insurer, financial institution or specialised administration outsourcer and do not wish to charge or suffer VAT which could be irrecoverable in the supply chain).