Employers face higher costs due to VAT changes

United Kingdom

From 31 December this year, employers must implement new HMRC rules on when they are able to recover VAT on defined benefit pension scheme costs. With less than three months to go, and no sign of promised HMRC guidance, many employers face yet another unwelcome increase in their pension costs.

Business activities

Until now, HMRC has allowed employers to recover VAT on services to DB scheme trustees, such as scheme administration and actuarial advice, as a general cost of an employer’s business activities. However, HMRC considered the management of scheme assets to be separate from the employer’s business. VAT charged by fund managers for investment management services could not be recovered by the employer.

PPG and beyond

Following the 2013 decision of the European Court in the PPG case, HMRC now says that, in the future, employers must actually receive the benefit of any services, and pay for those services, in order to recover the VAT.

Unfortunately, this change of approach has caused a collision between three hugely complicated areas: indirect tax (ie VAT), direct tax (ie corporation tax) and pensions regulation. It is proving hard to find a solution which meets the new VAT requirements whilst not causing problems in other areas.

Tripartite contracts

HMRC’s initial suggestion was that those providing services to trustees should change their contracts and make the employer a party to the contract. Under this tripartite contract, the employer would be entitled to receive the services and would be obliged to pay for those services, even though the trustee might be the one appointing the service supplier.

That is fine in theory, but can cause all sorts of problems because the interests of the employer and the trustees are not always the same. Actuaries, auditors and lawyers all have to comply with professional standards relating to managing conflicts of interest and trustees are usually keen to ensure that they have access to confidential and independent advice. Whilst it may be fine for scheme administrators and investment managers to contract with both the trustees and the employer, it is much harder for advisers to do so.

APL Proposal

In order to overcome these regulatory problems, the Association of Pension Lawyers put forward an alternative approach. This would involve making a single amendment to the rules of each scheme. The aim of that rule is to make clear that the activities of the trustees were part of the business of the employer because the trustees were running the employer’s pension scheme on behalf of the employer.

A neat solution from a pensions perspective, but we are battling against a long and complicated trail of VAT law. For this solution to work, we need to convince HMRC that this is sufficient to create a deemed supply to the employer, even though the employer is not party to the contract with the service supplier. We say pension schemes are a special case, but are yet to persuade HMRC of this fact.

What about the money

Even if employers do put in place an arrangement which allows them to recover VAT, they need to be careful not to cause perhaps greater problems elsewhere. For starters, if employers have to pay the fees themselves, will they be able to get an appropriate reduction in their contributions to the pension scheme, or will they just suffer a cashflow loss?

An even bigger issue is that investment management expenses are, under accounting standard IAS19, not put through the profit and loss account. This means that if an employer pays the investment management fees it may suffer a corporation tax hit.

Out of time

Industry bodies and interested parties are busy trying to find solutions which get through this minefield. Despite these efforts, it is currently looking like there is not going to be one solution which works for all costs and for all employers. However, what everyone agrees on is that HMRC has not left employers enough time to implement these changes.

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