Pension Fund VAT

After a period of uncertainty and change a few years ago, the VAT regime for pension funds has thankfully been quite stable recently. We are though continuing to see queries from organisations about the VAT efficiency of their arrangements. This article provides an overview of actions that a pension scheme or its sponsoring employer may wish to consider.

VAT registration

Many pension schemes are not registered for VAT, meaning that any VAT incurred on professional fees is irrecoverable, leading to increased costs. 

The first action to address is whether a VAT registration can be obtained and, if so, whether it is worthwhile doing so to allow (some or all) VAT to be reclaimed. A common misunderstanding is that a VAT registered person can recover all VAT they incur; this is not the case, as the recovery of VAT is dependent on the organisation making ‘taxable supplies’. VAT registration may be compulsory (if taxable supplies are in excess of the mandatory VAT registration threshold of £85,000 per annum are made) or voluntary (where taxable supplies below the threshold are made). With voluntary VAT registrations there is effectively a cost v benefit calculation needed to determine the best course of action, especially given there is a cost (either internal staff time and/or external professional fees) to maintaining a registration, filing VAT returns every few months and in responding to HMRC queries. 

Once a person is registered, or liable to be registered, they must account for VAT on the taxable supplies they make. They can, however, recover VAT paid on business purchases used in making those taxable supplies. For most pension schemes, the main source of taxable income is derived from commercial property transactions which is subject to an option to tax. Most income from financial investments is VAT exempt and may not on its own enable VAT registration.

Recovering VAT

The recovery of VAT on costs incurred by pension funds has been subject to legal challenge which led to a review by HMRC and new guidance being issued in late 2017. While some advisers expected there to be further developments, the 2017 guidance remains extant.

In establishing whether VAT incurred on a cost consideration has to be given to:

1. whether it is VAT for the sponsoring employer or pension scheme to reclaim
2. how much of the VAT incurred is recoverable.

HMRC draw a distinction between the VAT recovery position for:

1. administration
2. investment related costs.

The dividing line between the two categories can be a subjective one and not always easy to classify. As VAT is a self-assessed tax our recommendation is that the organisation documents the basis for the decision it has taken as that demonstrates ‘reasonable care’ in the handling of its VAT compliance position.

For the recovery of VAT on investment management services, the employer only has an entitlement to reclaim any of this VAT when it contracts directly with the supplier and pays for the services. The amount it can recover depends on the nature of the supplies that it makes.

For administration costs, it is often the case that the sponsoring employer can reclaim more VAT than the pension scheme, and therefore it is more VAT efficient for suppliers to invoice the sponsoring employer. Note that it is preferable if the suppliers engage with and issue invoices in the name of the sponsoring employer, but HMRC are known to accept VAT recovery by the employer, provided the invoice is addressed to it, even where the contract for services is in the name of the pension scheme. Where a sponsoring employer incurs costs of the pension scheme it may recover the VAT and then on charge the services to the pension scheme. It does not need to charge VAT on the element relating to administration but it would have to for investment services.

Some pension schemes prefer to receive the administration costs directly and to then on-charge them to the sponsoring employer. Under these arrangements the pension trustees will have to VAT register to charge VAT to the employer who will then reclaim it in accordance with their partial exemption position.

It is worth noting that there can be situations where the pension scheme has a greater level of VAT recovery than the sponsoring employer (for example, where the employer is a financial services or gaming business). In this scenario, it is likely to be more VAT efficient for the services to be supplied to the pension scheme and not recharged to the employer.

Finally, there is a long-established concession known as the 70:30 simplification which (surprisingly to some) was retained by HMRC in their 2017 update to their guidance. Where the supplier issues a single invoice covering a mix of both administration and investment charges, the simplification allows 70% of the VAT incurred to be attributed to investment management and 30% to administration with the pension scheme and the employer recovering their respective elements according to their VAT recovery positions.

In summary

Incurring VAT which cannot be reclaimed gives rise to significant additional costs. There are actions that pension schemes and their sponsoring employers can take to reduce costs by improving the efficiency of their VAT arrangements. This can include registering the pension scheme for VAT (where relevant supplies are made) and working with suppliers to ensure that contracts and invoices are structured in such a way to maximize VAT recovery.

In our experience, the VAT arrangements in place between sponsoring employers and pension funds are often longstanding and not frequently reviewed. There can also be inadequate communication between the teams responsible for each area. This can lead to potentially incorrect or inefficient arrangements being adopted and/or a lack of appreciation of the significance of certain requirements, for example the distinction between ‘administration’ and ‘investment’ and the need for VAT invoices to be appropriately addressed. Similarly, changes to existing invoicing or contracts may have a knock-on effect on VAT recovery so, from a governance perspective, we recommend that the VAT impact of any changes are considered prior to changes being enacted and that there is some form of regular review to ensure that the documentation and VAT position remains as all stakeholders expect.

For further information, please contact Robert Marchant or your usual Crowe contact.