Pensions World

Schemes should hope for the best but prepare for the worst while awaiting the decision in the Wheels case advises Nick Warner, PKF Accountants & Business Advisers

Investment fund managers and their clients are carefully watching the progress of a European Court case which could mean VAT exemption for fees charged for the management of pension schemes. The case, brought jointly by Wheels Common Investment Fund and the National Association of Pension Funds (NAPF), is expected to be decided in late 2012. 

While exemption would be good news for the funds themselves, which stand to benefit from retrospective VAT refunds, a court victory for Wheels could present a considerable administrative and financial headache for pension scheme managers and third party providers of administration services. To add to the uncertainty, there is no guarantee that the ongoing EC Financial Services Review will recommend keeping the exemption in the long term, putting managers under even more pressure to make the most of this claim opportunity. There are also other cases moving through the UK and European courts which could affect the practical impact of Wheels, all adding up to a period of uncertainty for the sector as far as VAT is concerned.

At this stage, fund managers should start planning how they will deal with clients’ claims for VAT refunds should Wheels win its case, and consider the potentially adverse effects on the amount of VAT they can recover on their own overheads. Also, many managers may have already submitted protective claims as long ago as late 2007/early 2008 – these could be due or even overdue for renewal under HM Revenue & Customs’ (HMRC) four year capping rules and should be reviewed immediately.

What is the Wheels case about?

While financial instruments themselves are VAT exempt, financial advice and management is generally subject to VAT at 20%. However, EU law allows fees charged by fund managers for managing “special investment funds” to be exempt from VAT.

Historically, HMRC limited the exemption to management fees for open ended investment companies, authorised unit trusts and trust based schemes. Then, in 2007, the JP Morgan Claverhouse decision in the European Court of Justice (ECJ) established that the exemption could also cover some closed ended funds. This prompted HMRC to add investment trust companies and venture capital trusts to the list of funds whose management fees were eligible for the exemption.

With the support of NAPF, the Wheels case has been brought to test whether the JP Morgan decision should also extend the VAT exemption to the management of occupational pension schemes. Although full details have emerged only recently, the Wheels litigation began over four years ago and many fund managers already have protective claims lodged with HMRC to ensure maximum refunds if pension scheme management is found to be VAT exempt. 

What does it mean for scheme managers and their clients?

A victory for the appellants in Wheels would be very good news for pension schemes, which stand to recover years of overpaid VAT. In addition, third party administration services to a fund manager may also become exempt from VAT if such services are deemed as specific to and essential for the management of the fund.

Exemption will be less welcome for fund managers (and exempt administrators), who will not benefit financially in their own right and, under current rules, will also be faced with the administrative burden of claiming overpayments from HMRC and refunding them to clients. To add insult to injury, many managers could see their recovery of VAT on overheads reduced or even wiped out, as a higher proportion of exempt income will be generated. If a retrospective claim is made, the VAT recovery restriction must be backdated, too. This would leave the fund manager out of pocket as the newly irrecoverable input VAT cannot be offset against the overcharged output VAT, which must be paid back to the pension scheme. However, managers should consider the potential impact of the very recent Investment Trust Companies case, which might excuse them from this unpleasant scenario (see below).

What other developments might affect the VAT position?

The Wheels decision is unlikely to be the end of the matter. No less than three other developing issues could have a bearing on the long term VAT position of scheme management.

While the Wheels case focuses on the definition of a special investment fund, the GfBK case, an ECJ referral from Germany, will decide on another aspect of VAT on scheme management. In GfBK, the court will have to consider which services qualify as “management” for the purposes of the VAT exemption and, in particular, examine the distinction between management and advisory services and the delegation of services to third parties.

The outcome of the EC Financial Services Review, which has been under way for several years, is expected to herald a completely new VAT regime for finance and insurance in the future. For the UK financial services industry, which is arguably subject to a more relaxed VAT regime than its EU counterparts, exemption will probably become much harder to achieve overall. Current progress reports, however, indicate that the review may come out in favour of long term exemption for pension scheme management. There are, of course, no guarantees until the review is concluded and we still do not have a clear timeframe for when the outcome will be announced and implemented. Still, it is conceivable that the ECJ’s rulings in both Wheels and GfBK may be quickly superseded, raising the possibility that fund managers will have to make historic claims for overpaid VAT, only to be forced to start charging it again in the not too distant future.

Finally, a decision from the UK High Court offers a ray of hope to fund managers who dread the prospect of rewriting their recent VAT history if Wheels wins. The Investment Trust Companies case, another JP Morgan spin off, was released in early March and raises the possibility of funds being allowed to recover overpaid tax directly from HMRC instead of through their fund managers. The High Court has decided that this approach could be legally possible under restitutionary law were it not for a single blocking provision in the VAT law. Aspects of this are already under scrutiny in two other tax cases (Littlewoods and the FII Group Litigation), so the High Court has postponed its deliberations to wait for those to be decided – this is expected to happen before the Wheels judgment is issued. If direct refunds ever become a reality, this would be an enormous relief for fund managers, but the concept still has a number of legal hoops to jump through so cannot be relied upon as a get out clause just yet.

What should fund managers do?

There are many variables at play here which could affect the final position for everyone involved – a good example of why one should always “hope for the best, but prepare for the worst”.

Seeking expert advice on these issues at an early stage and getting help with the preparatory work will reduce the challenges that these VAT changes are likely to bring.