VAT and defined benefit schemes: taxing times ahead

It is more than three years since the European Court ("CJEU") rulings in Wheels and PPG, in which the CJEU found that (a) the supply of investment management ("IM") services to Defined Benefit ("DB") pension schemes was subject to VAT and (b) scheme sponsors could reclaim that VAT.  However, the treatment of IM services supplied to DB schemes remains uncertain.

• Further claims against HMRC are progressing in the UK Courts, challenging the CJEU's conclusion that the supply of IM services to DB schemes is subject to VAT.
• HMRC have faltered in their attempts to formulate definitive guidance on the circumstances in which scheme sponsors can recover VAT on IM services (assuming that such services are subject to VAT).

This article (a) examines the merits of the current claims against HMRC and (b) how scheme sponsors might restructure their arrangements in order to secure recovery of VAT on IM services (if the current claims against HMRC prove unsuccessful).  In summary:

• There is a prospect that the Courts will decide that no VAT is payable in respect of IM services supplied to DB schemes, notwithstanding that there have been two CJEU decisions to the contrary.
• From a tax perspective, it seems possible to structure arrangements such that VAT can be recovered by the sponsor without exposing that sponsor to other negative tax consequences feared by HMRC.

Is investment management of DB schemes subject to VAT?

Background

The EU VAT directive requires Member States to exempt from VAT "the management of special investment funds, as defined by Member States".   The discretion of Member States¹ to define what is a "special investment fund" is not a discretion at large.  The CJEU has made clear that, when defining "special investment funds", Member States have to include all forms of domestic undertakings which are (a) undertakings for collective investment in transferable securities ("UCITS") or (b) sufficiently comparably to UCITS.

The UK law implementing the EU law originally defined special investment funds as including only authorised unit trusts and open ended investment companies.  Following litigation involving the investment trust community, the definition was extended to include other forms of investment fund.  However, the definition was not extended to include pension funds.

Against that backdrop came the Wheels litigation.  In that case, a number of DB schemes trustees claimed that their DB funds were special investment funds, hence had erroneously been charged VAT by their investment manager.  They wanted HMRC to repay the VAT that had been paid.

The Wheels litigation ended up in the CJEU, where the Court decided, in essence, that DB schemes were insufficiently comparable to UCITS, thus preventing them from being special investment funds.  The CJEU reiterated that position in PPG less than six months later.

Not the end of the matter?

Two further cases, United Biscuits² and First State³, are challenging the CJEU's conclusion in Wheels and PPG.  The principal argument being advanced in both cases is, in essence, as follows:

• One aspect of the EU law principle of fiscal neutrality is that services which are in competition and sufficiently comparable should not attract different VAT treatment.
• In the investment management market, insurers and non-insurers compete to provide IM services to DB schemes.  Those IM services are essentially identical.
• HMRC have always accepted that where IM services are supplied by insurers, those supplies are exempt from tax.  Therefore, in accordance with the principle of fiscal neutrality, HMRC should ensure that where IM services are supplied by non-insurers to DB schemes, they should also be exempt.

At first blush, the argument being advanced might face some challenges.  To the extent that the supply of IM services by an insurer has been treated as exempt, it can only be because it falls within the exemption for "insurance and reinsurance transactions" (Article 135(1)(a) PVD).  Since the principle of fiscal neutrality (as a principle of statutory construction) cannot be relied upon to extend clear wording in an exemption,⁴ it may be that the CJEU would be reluctant to extend the exemption for insurance and reinsurance to IM services supplied by non-insurers.

However, the CJEU might be more willing to take a different position from that taken in Wheels and PPG if the argument is cast slightly differently, with the principle of fiscal neutrality being relied upon to extend the meaning of the more ambiguous phrase "special investment funds" (Article 135(1)(g) PVD) in order to achieve parity of treatment with insurers.  That argument appears to have been made in the First-tier Tribunal in Wheels,⁵ albeit the published decision (and the decision of the CJEU) suggests that it was not advanced with any force; or, at least, the Tribunal and CJEU did not grapple with the issue to any material extent.  In that regard, it is notable that, following the CJEU decision, the Wheels litigation continues in the Tribunal, and Wheels has been granted permission by the Tribunal to reformulate its case (in view of the arguments being advanced in United Biscuits).⁶

It is possible that United Biscuits (a case involving a direct claim by an end consumer, as opposed to the supplier responsible for accounting to HMRC for VAT charged in respect of the IM services) may be dealt a mortal blow by the forthcoming decision of the Supreme Court in the Investment Trust Companies litigation.⁷  (That case, among other things, raises the question of whether a claim can be made against HMRC directly by the end consumer of services, as opposed to the supplier.)  Hence it may be that First State (a claim by the IM supplier) provides the next substantive instalment in the DB scheme saga.

Can a sponsor recover VAT?

HMRC's position

If one assumes that IM services provided to DB schemes are not exempt (and VAT is payable), the issue becomes who, if anyone, can reclaim that VAT?

Historically, HMRC were not willing to accept that the relevant employer (as opposed to the DB scheme itself) was entitled to recover the input VAT paid in respect of any IM services provided to the scheme.  HMRC's position changed with the decision of the CJEU in PPG, following which HMRC accepted that an employer could recover input VAT paid on IM services, but only where it was the recipient of those services.  That, effectively, required that the employer should have been the party contracting for, and paying for, those services.

In briefs issued during 2015,⁸ HMRC proposed three structures it hoped would secure that input VAT deductions could be obtained by the employer.  First, a tripartite arrangement, pursuant to which the employer and scheme contract with a third party for the provision of management services, and the employer agrees to pay for those services.  Second, a recharging arrangement, where the scheme contracts with a third party for the provision of management services, and then enters into a back to back contract to provide the same services to the employer.  Third, VAT grouping the scheme with the employer.

The second and third scenarios come with difficulties which, as HMRC recognise, might result in only partial recovery of input VAT or expose the DB scheme's assets to increased risks.  However, somewhat perplexingly, HMRC also seem to have convinced themselves that the first option (the tripartite arrangement) has adverse corporation tax consequences.

A workable solution?

As regards tripartite arrangements, HMRC's concern appears to be that whilst such an arrangement would allow for the recovery of input VAT, any payments made by the employer would not be deductible for corporation tax purposes.  In that case, the employer could end up in a worse after-tax position than if the scheme had simply born the irrecoverable VAT and the employer had reimbursed it (and claimed a corporation tax deduction in respect of that reimbursement).

HMRC's reasoning in that regard seems to be that the tax treatment of the payments follows the accounting treatment, and for accounting purposes the payment would not go through the profit and loss account; rather, it would be accounted for in the statement of "other comprehensive income".  However, it seems that this reasoning might not be entirely sound since the deductibility of a payment (for corporation tax purposes) does not turn on whether an amount appears in the profit and loss account: the requirement is that the expenditure was incurred wholly and exclusively for the purposes of the trade, and was computed in accordance with generally accepted accounting practice (whether included in the profit and loss account, statement of other comprehensive income, or elsewhere).⁹   The authors await with interest to see whether HMRC revisits its analysis in this regard.

¹ Article 135(1)(g) Council Directive 2006/112/EC ("PVD")
² HC-2014-000546, Chancery Division
³ TC/2015/04983
⁴ See, for example, Finanzamt Frankfurt am Main V-Hochst v Deutsche Bank AG (C-44/11) at [45]
⁵ [2011] UKFTT 534 (TC) at [15]
⁶ [2017] UKFTT 830 (TC)
⁷ HMRC v Investment Trust Companies (in liquidation) and others, on appeal from the Court of Appeal ([2015] EWCA Civ 82)
⁸ Revenue and Customs Briefs 8 (2015) and 17 (2015)
⁹ Sections 46 and 54, Corporation Tax Act 2009