HMRC have announced that they will withdraw their policy of allowing insurers to treat supplies of fund management services to pension funds which do not qualify as special investment funds (SIFs) as VAT exempt insurance with effect from 01 April 2019: Revenue & Customs Brief 3/2017.
The change has no doubt been prompted by further litigation in the United Biscuits and Wheels cases concerning supplies of fund management to defined benefit pension schemes. Arguments raised in those cases concern the impact of fiscal neutrality on HMRC’s treatment of fund management by an insurance company compared with similar fund management services by non-insurers.
As a result of the decision, insurers supplying investment management services to pension schemes which do not qualify as SIFs will, from April 2019, be required to charge and account for output VAT on their services. Insurers supplying investment management services will, therefore, for the first time need to assess whether the recipient pension fund qualifies as a SIF or not. To the extent that insurers will be required to charge VAT on their investment management services, recipient funds will be left with irrecoverable input VAT.
The VAT treatment of pension funds and investment management services provided in relation to investment funds has been a fertile area of dispute in recent years. There have been CJEU decisions and HMRC guidance on employers’ rights to recover input VAT on employer funded pension schemes and decisions on the VAT treatment of investment management services provided to defined benefit (DB) and defined contribution (DC) pension schemes.
In particular, the ECJ decision in Wheels held that a DB pension scheme would not normally benefit from the VAT exemption for management services provided to SIFs. In Wheels, HMRC successfully argued that since the schemes in question were DB schemes, the benefits received by employees from such schemes depended on length of service and salary, rather than investment return. Therefore, such funds were fundamentally different to "special investment funds" where returns depend on the amount invested, the performance of the fund and any fund charges. Accordingly, the VAT exemption for investment management services provided to special investment funds did not apply.
In contrast, in ATP Pension Services, the ECJ held that a pension fund which pooled investments from a number of DC pension schemes qualified as a SIF for the purposes of the VAT exemption for fund management services. HMRC now accept that DC pension funds that have the required characteristics are SIFs for the purposes of the fund management exemption, so that the services of managing and administering those funds are, and always have been, exempt from VAT.
Despite the Wheels decision, a second line of argument for exempting supplies of investment management to DB pension schemes has emerged based on fiscal neutrality and has been making its way through the UK courts.
A claim lead by United Biscuits pension fund trustees has alleged that the failure to extend exemption to investment management services provided to DB pension schemes breaches the EU principle of fiscal neutrality. This is based on the differing VAT treatment of investment management services provided to occupational pension schemes by insurers and non-insurers.
The claim alleges that, in practice, investment management services provided by an insurer to DB pension fund trustees (which have been treated by HMRC as an exempt insurance related service under Group 2 of Schedule 9 to the VAT Act 1994) are functionally identical to other investment management services provided to DB fund trustees by non-insurers and which are subject to VAT. Accordingly, the claimants argue that since the services are identical and meet the same needs of the recipient, regardless of whether they are provided by an insurer or a non-insurer, the EU principle of fiscal neutrality requires the investment management services be exempted from VAT even if provided by a non-insurer.
On its return to the domestic courts, Wheels has also been allowed to amend its claim for repayment of overpaid VAT to encompass these new arguments based on fiscal neutrality. See our article, “Wheels keep turning”.
Revenue & Customs Brief 3/2017
Whilst the Brief does not specifically mention the continuing appeals based on fiscal neutrality, it seems clear that HMRC have been prompted to act by the arguments put forward in these cases. One could, perhaps, read into this a concern on the part of HMRC that the fiscal neutrality arguments being advanced in United Biscuits and the amended Wheels claim may have some merit.
The Brief recognises that UK policy has continued to allow insurers to exempt supplies of pension fund management services, despite the decision in Card Protection Plan that the EU insurance exemption applies only to the underwriting of risk and doesn’t apply to other supplies made by insurers. The retention of this policy was in part a result of uncertainty arising from the EU Commission’s review of the VAT treatment of financial services which began in 2006 and which created an expectation that it would result in a future exemption for all pension fund management services. However, there is now no current prospect of that review resulting in reform and HMRC have decided that the policy can no longer be maintained, notwithstanding that one could argue that given Brexit, there is no pressing need to review this policy, and certainly not with less than three months for affected taxpayers and pension funds to adapt to the change.
However, whilst withdrawing their general acceptance that investment management provided by insurers is an exempt supply, HMRC do accept that, following the decision in ATP, most DC pension schemes will qualify as SIFs for the purposes of the VAT fund management exemption. As such, the withdrawal will only affect supplies of fund management services by insurers to non-SIF pension schemes, such as the DB schemes which were the subject of the Wheels appeal or DC arrangements not meeting the ATP requirements, such as SIPPs where there is no pooling of contributions.
Insurers and their pension fund clients will now need to actively address the question of whether the funds to which they provide services can be regarded as SIFs for VAT purposes. If not, insurers providing investment fund management services will need, from April 2019, to charge VAT on their fees which will result in irrecoverable input VAT for their non-SIF pension fund clients.
HMRC’s treatment of supplies of investment management by insurers as exempt insurance always appeared to be concessionary. However, the treatment was long-standing and, prior to the United Biscuits case, there did not appear to be any suggestion that HMRC would withdraw such treatment. As such, even if the taxpayers in United Biscuits and Wheels succeed (should those cases be allowed to proceed following the decision in the Investment Trust Companies case), any victory would very much be a pyrrhic victory given HMRC’s decision to apply the law strictly from April 2019 onwards.
More generally, it is understood that, following discussions between HMRC and the Investment Association, HMRC accept that the changes to pension fund management services provided by insurers will primarily affect the management of defined benefit pension schemes. HMRC accept that the change will not affect the management of defined contribution occupational and personal pension funds (which generally qualify as SIFs) or the management of assets under a pension contract or annuity taking the form of a contract of insurance. No further details are given at this stage, however, and further information from HMRC may be required to determine the exact scope of these exceptions.
Although the brief deals solely with the position of pension fund management services provided by regulated insurance companies, it will be interesting to see whether there could be wider implications, for example in respect of investment bond products provided via insurance wrappers.
For the VAT implications of supplies spanning a change of rate or liability, see our article "Time of supply: Practical implementation of HMRC’s withdrawal of the insurance exemption in respect of pension fund management"
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