Pension schemes and VAT: where are we now?

Transcription

1 Pension schemes and VAT: where are we now? December 2015 Pension briefing HIGHLIGHTS At the end of October, HMRC issued a long-awaited further brief on VAT (2015/17)). As was widely hoped, the transitional period for complying with the new VAT regime has been extended to 31 December The extension is welcome although uncertainties remain about the options available to trustees and employers keen to minimise their VAT liability in relation to occupational pension schemes. At present, paymaster arrangements (explained below) seem the most attractive option for most defined benefit (DB) schemes. Brief 2015/17 is focussed on DB schemes. Details of VAT recovery or exemption for defined contribution (DC) schemes remain opaque. This note sets out the current state of play in relation to VAT on services to pension schemes and recommends steps for employers and trustees to take to optimise recovery of future (and, in some cases, historic) VAT. BACKGROUND Historically, HMRC divided the services received by occupational pension schemes into: administration services; and investment services. HMRC allowed sponsoring employers of pension schemes to recover VAT on administration services but not on investment services. Where services straddled both, it allowed a split of 70/30 (where 30% of the invoice was attributed to "administration" and VAT could, therefore, be recovered on that part). Decisions of the Court of Justice of the European Union, "PPG" and "ATP", in 2013 and 2014 prompted HMRC to rethink its position. Now, in relation to DB schemes, it should be possible to continue 100% VAT recovery on administration services, although in order to achieve this trustees and employers will need to put in place additional structures as described below. These structures may also allow some VAT recovery on investment services, although it seems that it will not be possible to achieve 100% VAT recovery on these services without losing some of the employer's corporation tax deductions. In relation to DC, some services provided to DC schemes will be exempt from VAT. It may be that non-exempt services to DB schemes will be recoverable but further guidance is awaited from HMRC. POTENTIAL "SOLUTIONS" FOR DB SCHEMES During 2014 and 2015 HMRC has issued a number of Briefs setting out possible ways in which employers could recover VAT on pension scheme expenses under the new interpretation of European VAT requirements. Unfortunately, the more thinking that was done by HMRC and the pension industry, the more potential difficulties arose with the potential "solutions". Solutions which are currently available in respect of DB schemes are explained below. PAYMASTER ARRANGEMENTS (ALSO KNOWN AS "BACK TO BACK") What is a paymaster arrangement? Under a paymaster arrangement, the trustee enters into a contract with the employer to provide the services of running the pension scheme. The trustee registers itself for VAT and invoices the employer for its services as trustee (adding on VAT). The employer pays the invoice and, providing it is making VATable supplies, recovers the VAT charged from HMRC. The trustee contracts with various service providers (legal, actuarial, administration, etc) and pays VAT, where applicable, on their fees. The trustee can then offset the VAT it pays on service providers' fees against the VAT it charges the employer. For services where both the employer and the trustee have full VAT recovery, the trustee and the employer will end up in the same position as if the employer had contracted directly with the service provider and had recovered the VAT on the provider's fees. The example below illustrates how a paymaster arrangement might work. In this example, the trustee pays fees to service providers totaling 300 (plus 60 VAT) and charges the employer 300 (plus 60 VAT) for the service of running the pension scheme. The trustee does not add a profit element to the fee it charges the employer and will not, we understand, be treated as "trading" for corporation tax purposes.

2 2 PAYMASTER - EXAMPLE What services does paymaster work for? In most cases, a paymaster arrangement should allow the trustees and employer full VAT recovery in respect of noninvestment services. The position in relation to investment management fees is different, as historically HMRC seems to have considered that a trustee's investment activities would be undertaken on its own behalf, rather than as part of the general running of the scheme. To the pensions industry, this seems a strange position as it is difficult to understand what investment activities the trustees might carry out on their own behalf rather than as part of providing the benefits due under the scheme. In a departure from its previous stance, HMRC has now said that a trustee may recover part of the VAT it is charged on investment management fees, because HMRC considers that this VAT relates to both the trustee's service of running the pension scheme on behalf of the employer and to its own investment activities. HMRC believes that the VAT which relates to the trustee's own investment activities is not recoverable, but VAT in respect of running the scheme on behalf of the employer is. It is not yet clear how the VAT on the investment management fees should be apportioned between these different activities. In our example, we assume that 60% of the investment manager's services provided to the trustee relates to the trustee's own investment activities, with 40% related to the service of running the scheme for the employer. Although the trustee charges 20 VAT to the employer that (effectively) relates to the investment services provided, the trustee may only offset 8 (40%) of the VAT it incurs on the investment manager's services against the VAT it must account for to HMRC on its service of running the scheme, and so must account to HMRC for the remaining 12 (60%). This means that there is a tax leakage of 12 in this example. Paymaster arrangements: advantages The trustee contracts with the providers no need to renegotiate contracts. No conflict of interest issues (the trustee contracts direct with the providers). Full recovery of VAT on administration fees and partial recovery of VAT paid on investment management fees. Paymaster arrangements: disadvantages The trustee will need to register for VAT and will need to submit VAT returns. Only partial recovery of VAT will be allowed on investment management services. It is currently not clear what proportion of VAT on investment management services HMRC is likely to accept may be recovered. Potential loss of dormant company status, with consequent potential obligations to file accounts and returns with Companies House.

3 3 How would we set up a paymaster arrangement? Various steps would be needed: The trustee should register for VAT. (Individual trustees may register but the process is simpler with a corporate trustee individual trustees and their sponsoring employers should consider incorporation.) Scheme rules should be checked and, where necessary, amended to allow the new arrangement. Processes should be set up for the trustees (rather than the employer) to pay the providers of services to the trustee. A written contract will be needed between the trustee and the employer for the provision of services by the trustee. The trustee will need to submit VAT returns and comply with any other requirements for being VAT registered. TRIPARTITE CONTRACTS What is a tripartite contract? A tripartite contract involves the trustees, employers and service provider entering into a joint contract. Such contracts provide evidence that services are provided "to" the employer. In an earlier Brief (2015/8) issued in March this year, HMRC confirmed that tripartite contracts can work and set out the features that it would expect to see in an investment tripartite contract to enable an employer to recover VAT. These included that: the service provider makes its supplies to the employer (although the service provider may be appointed by, or on behalf of, the trustees); and the employer directly pays for the services supplied under the contract. No such guidance has been provided in respect of what features HMRC would expect to see in a tripartite contract for administration services. Tripartite contracts corporation tax issue HMRC's thinking on tripartite contracts has moved on since it issued Brief 2015/8. In particular, it believes that employers may not claim a corporation tax (CT) deduction on any investment management fees paid under a tripartite contract. (Under current arrangements, employers benefit from a CT deduction in respect of contributions to the scheme these contributions effectively fund investment costs.) For most employers the advantage of reclaiming VAT paid on investment management fees would be offset by the lack of a CT deduction in respect of the fees. Tripartite contracts where are we now? The inability of an employer to claim a CT deduction on investment management costs it pays significantly reduces the attraction of tripartite contracts. Tripartite contracts: advantages Only option which enables full reclaim of VAT paid in respect of both administration and investment management services. Tripartite contracts: disadvantages No CT deduction in respect of investment management fees paid by the employer. Need to renegotiate contracts with suppliers. Gives rise to significant conflict concerns for "conflicted services" (such as legal or actuarial advice where the interests of the employer and the trustee may diverge). Investment fees are usually related to the value of funds under management and so can vary significantly from one year to the next. Payment of the fees direct (rather than by the provider deducting its fee from the funds it manages) can create budgeting and cash flow difficulties for the employer. Simply offsetting the investment fees against the employer's contributions to the scheme would not work in practice as HMRC considers this would create an additional VAT charge, which would negate the VAT benefit of entering into the tripartite contract in the first place. VAT GROUPING VAT grouping involves adding a corporate trustee as a member of the employer's wider VAT group. This enables employers to recover the VAT paid by the trustee although great care is needed because including the trustee in the VAT group can adversely impact the overall VAT recovery of the group as a whole. HMRC's original position was that VAT grouping only allowed VAT recovery for administration services. However, as with paymaster arrangements, HMRC has shifted its position on recovery of VAT on investment management fees. Partial recovery may now be possible, although HMRC still appears to believe that part of the management of the scheme's assets relates to the trustee's own "investment activities", rather than to the provision of benefits which have a direct link to running the employer's business. Only VAT in relation to investment services that have a direct and immediate link to VATable supplies made by the employer may be recovered. Again, HMRC has given no indication of the proportion of VAT it is likely to accept would relate to the employer's supplies. VAT grouping: can trustees be liable for additional VAT? Members of a VAT group are jointly and severally liable for VAT in respect of all members of the group. This has led to concern that pension scheme trustees would be liable for unpaid VAT liabilities of other members of the VAT group and that HMRC could reclaim this VAT due from the scheme assets. HMRC has been advised that it cannot recover VAT in respect of other entities from pension scheme assets. Our analysis is that, under general trust law principles, it would be right that assets of the scheme would be safe from claims by HMRC. However, we can see no protection for the trustee, which would be jointly and severally liable in the same way as any other company in the VAT group. In addition, we suspect that HMRC's opinion may not take account of indemnities in pension scheme trust deeds, which commonly indemnify the trustee out of the scheme assets for any liability it incurs as trustee. This would include VAT liability. Advantages of VAT grouping Enables recovery of VAT on pension scheme administration costs and partial recovery on investment management costs.

4 4 Disadvantages of VAT grouping Care must be taken that inclusion of the pension trustee in the employer's VAT group does not adversely affect the VAT recovery of the group as a whole. Only partial recovery of VAT will be allowed on investment management services. It is currently not clear what proportion of VAT on investment management services HMRC is likely to accept may be recovered. The pension scheme trustee would be jointly and severally liable for the VAT liabilities of the whole VAT group. The trustee must both be a corporate and meet the eligibility (control) requirements for being within the employer's VAT group. Questions remain as to whether the scheme assets would be at risk should VAT liabilities of other members of the VAT group remain unpaid. DB SCHEMES: SHOULD WE DO ANYTHING ABOUT THE PAST? Our view is that, on the basis of HMRC's guidance, there is little to be done in respect of historic VAT already paid. VAT charged on administration services should have been recoverable under HMRC's historic policy. In relation to VAT previously paid on investment services, HMRC currently requires contemporaneous evidence that the services were provided to the employer. This makes it very difficult for employers to reclaim historic VAT on investment services without seeking to challenge the fundamental premise of HMRC's position. However, we understand that some taxpayers are considering challenging HMRC's policy in this area. DEFINED CONTRIBUTION ("DC") SCHEMES: WHERE ARE WE NOW? HMRC now accepts that "pure" DC schemes are exempt from paying VAT on investment management services and, potentially, some administration services. This is on the basis that they are "Special Investment Funds" for the purposes of European legislation. HMRC's position on hybrid schemes, schemes with money purchase underpins, and DC additional voluntary contributions (where the principal benefits are DB) remains unclear. Investment management services If trustees of DC schemes have not already done so, they should ensure that they are not charged any VAT on their investment management services going forward. Trustees should also consider claiming back the VAT that has been overpaid historically (in the four years prior to the claim being made). We have prepared a Model Document to assist with this which clients are welcome to use (please see below). Administration services HMRC states that, as well as investment management services, the VAT exemption also applies to administration services that are integral to the operation of the pension fund, including the services of administering pension accounts. HMRC was expected to publish further guidance on which services it would consider exempt from VAT this past summer. Unfortunately, this guidance has not yet been issued. We recommend that clients wait for the further guidance and then contact their service providers for confirmation that VAT will no longer be levied on the services that HMRC confirms are exempt. Trustees will also, in some cases, be able to consider claiming back historic VAT on these services. We are also expecting further information from HMRC on the position of services that are not exempt from VAT. Specifically, we are anticipating guidance on whether any of the solutions for DB schemes (discussed above) can be applied to DC schemes. While the position is not completely clear until HMRC issues further guidance, we expect the services of administrators to be exempt from VAT in many cases. We understand that some administrators have agreed a position with HMRC and it is therefore worth trustees asking their administrator if they have considered the position on administration services. EXTENSION OF TRANSITIONAL PERIOD Schemes and employers were initially told that they could continue with existing arrangements (including the 70/30 split for combined services) only up to 31 December However, with various unforeseen legal issues and subsequent delays in issuing further guidance, it became apparent that employers and trustees would struggle to update their VAT arrangements in time. To the pension industry's great relief, HMRC accepted that more time is needed and on 26 October 2015 announced a year's extension of the transitional period. Employers and trustees now have until 31 December 2016 to update their VAT arrangements.

5 5 SUMMARY TABLE Administration Investment Defined benefit schemes / sections SUMMARY: there are three possible solutions: paymaster arrangements; tripartite contracts; and VAT grouping. ACTION: we suggest that clients "wait and see" until further HMRC guidance on paymaster arrangements is available. This is likely to be a simpler and more cost effective solution than either tripartite contracts or VAT grouping. In the meantime, current arrangements for reclaiming VAT on administration services may continue to be used. SUMMARY: following HMRC's change in direction, it seems that there are also three possible solutions: Paymaster arrangement - partial recovery only Traparite contracts - full recovery VAT grouping - partial recovery only However, given the CT issue, tripartite contracts may no longer be a realistic option. Paymaster arrangements and VAT grouping will allow partial recovery of VAT in respect of investment management services, although what proportion of this VAT may be recovered remains unclear. Defined contribution schemes / sections SUMMARY: it is clear that some administration services should be exempt from VAT. However, we are still awaiting guidance from HMRC as to which services fall within the exemption and which do not. ACTION: we suggest that clients "wait and see" until HMRC guidance on DC schemes is available. This should provide some clarity on what administration services HMRC accept should be exempt and whether the solutions that apply to DB schemes can be applied to DC schemes. Trustees could ask their service provider whether they have considered the position with HMRC. In the meantime, current arrangements for reclaiming VAT on administration services may continue to be used. SUMMARY: investment management services should no longer be subject to VAT. The critical issue is to identify whether any VAT is payable (many investment arrangements are already exempt) and, if it is, to confirm that VAT will no longer be charged. It may also be possible to recover historic VAT. ACTION: we suggest that investment management providers are contacted to confirm that they will no longer be charging VAT and have made historic reclaims. Please see the model document below. Significant concerns remain in relation to VAT grouping, meaning that paymaster is likely to be the most attractive option for many pension schemes and employers. ACTION: we suggest that employers and trustees take preparatory steps towards putting a paymaster arrangement in place: incorporating the pension trustee (if appropriate); investigating requirements for registering the trustee for VAT; checking and, if necessary, amending the scheme rules; and considering which administrative processes will need to change so that the providers may be paid by the trustee. Unless there is a particular reason to put a paymaster arrangement in place immediately, we recommend waiting to see whether HMRC gives further guidance on the proportion of VAT on investment management services that may be recovered.

6 6 MODEL DOCUMENT [Trustee Headed Paper] Dear [insert] [Insert scheme name] (the "Scheme"): Value Added Tax ("VAT") charged on investment management services to the Scheme We have in place a contract with you for the provision of investment management services to the [Scheme / [insert name of DC section] of the Scheme]. Historically we have been charged and paid VAT on those invoices. As you are no doubt aware, following a recent decision of the Court of Justice of the European Union, HMRC has revised its position (which is now set out in Revenue and Customs Brief 44/14) and confirmed that, since the Scheme [is a defined contribution scheme / services were provided to a defined contribution section of the Scheme] such services should not be subject to VAT. Please would you confirm at your earliest convenience that: You will no longer be charging VAT on your invoices; and You have applied (or will be applying) to HMRC for a reclaim of the overpaid VAT that we have been charged for the maximum period allowed by law and will refund this overpaid VAT to us once received from HMRC. We look forward to hearing from you. This note is written as a general guide only. It should not be relied upon as a substitute for specific legal advice. KEY HOGAN LOVELLS PARTNERS Katie Banks Duncan Buchanan Claire Southern Edward Brown katie.banks@hoganlovells.com duncan.buchanan@hoganlovells.com claire.southern@hoganlovells.com edward.brown@hoganlovells.com About Pensions360 Hogan Lovells' broad cross-practice capability covers the full spectrum of legal advice from lawyers who understand pension clients; advising on issues from scheme investments, corporate restructurings and transactions, to funding solutions and interaction with the Regulator or the courts. The ability to draw on specialists from other practices who are not only experts in their field but have an in-depth understanding of pension issues sets us apart from our competitors. "Hogan Lovells" or the "firm" is an international legal practice that includes Hogan Lovells International LLP, Hogan Lovells US LLP and their affiliated businesses. The word "partner" is used to describe a partner or member of Hogan Lovells International LLP, Hogan Lovells US LLP or any of their affiliated entities or any employee or consultant with equivalent standing. Certain individuals, who are designated as partners, but who are not members of Hogan Lovells International LLP, do not hold qualifications equivalent to members. For more information about Hogan Lovells, see Where case studies are included, results achieved do not guarantee similar outcomes for other clients. Attorney Advertising. Hogan Lovells All rights reserved. #