HMRC provides detail of new policy on input tax recovery for DB pension schemes

Prior to the apparent removal of the advantageous concessionary treatment in relation to administration costs, HMRC's position meant that it was far easier for employers to recover input tax on costs relating to the administration of DB pension schemes than on investment costs relating to management of the scheme's assets.

Input tax on administration service costs could be recovered by the employer as a business overhead, provided the VAT invoice was addressed to it - even if the pension fund trustee contracted and paid for the relevant services. This was not a 'normal' VAT invoicing arrangement; employers were able to do this because HMRC guidance expressly permitted it in respect of administration costs.  By contrast, input tax on investment costs could only be recovered in that way if the employer contracted and paid for the services itself.  However, as the trustee would typically (for non-tax reasons) be required or want to be party to the fund management contract, it was necessary to put complex arrangements in place to access this input tax recovery.  These include:

1) Tripartite contracts – this involves the services being provided under a tripartite contract between the service provider, the trustee and the employer. Although this route can lead to all the input tax being treated as the employer's, it is rarely used.  This is because it can give rise to a number of problems. including in relation to conflicts of interest (as the supplier is advising two clients with potentially differing outlooks) and the employer's ability to get a corporation tax deduction for the fees it pays for the services. 

2) VAT grouping – this involves bringing the trustee into the employer's VAT group, such that input tax incurred on investment services is treated as belonging to that group. This means that recovery is possible in accordance with the group's partial exemption recovery method – but at the cost of the trustee's presence in the group typically reducing the group's recovery percentage under that method. In addition, HMRC took the view that the investment services had a "dual use" - they were used both for the group's general business purposes AND for the trustee's investment activities, with input tax recovery only being possible for the former use. The apportionment between the uses was to be on a fair and reasonable basis (50% is often cited as a common figure – such that 50% would then be recoverable in accordance with the VAT group's partial exemption recovery method).

3) On-supply - this involves the trustee registering for VAT and making a taxable supply of scheme administration services to the employer (with the investment services received by the trustee forming part of that on-supply). However, as with the VAT grouping route, HMRC took the view that there was a "dual use" to those investment services – this time between the trustee's taxable supply to the employer and its ongoing investment activities, such that again, commonly only 50% of any VAT thereon would end up as recoverable.

However, last June, HMRC published a short policy paper announcing a change in policy. However, the detail of the new policy was unclear and could be read in two ways:

1)  The silver standard: abolition of the "dual use" concept only – to get the best input tax recovery position it would still be necessary to use one of the arrangements described above but that this would now result in up to 100% of input tax (rather than, for example, 50%) being recoverable.

2)  The gold standard: investment costs to be treated the same as administration costs – this would allow an employer to recover up to 100% of the input tax as a business overhead on investment services, provided the VAT invoice was addressed to it (even if the trustee contracted and paid for the services).

Explanatory guidance was promised "by autumn 2025".

On 4 June this year, HMRC provided the long-awaited detail as to their new policy, quietly updating the published guidance in their internal VAT Input Tax Manual.  

In an unexpected move, the new approach appears to depart from bespoke concessionary treatment for pension funds' costs, and, instead, seems to be based on more orthodox VAT principles according to which, essentially, input tax recovery is only possible for the person who contracts, and pays, for the supply. For these purposes, HMRC say that employers can "pay" for services by deducting the consideration from the pension pot, however, it is not entirely clear what this means.

In practice the new approach is good news for asset management costs (albeit it does not get us to the "gold standard" above) but less welcome for administration costs.

Asset management costs: the result of the new approach is in line with the "silver standard" (see above). HMRC accepts that if a trustee is brought into the employer's VAT group, the asset management (and administration) costs will be overheads of the group and deductible in accordance with the activities of the group as a whole, with the concept of "dual use" no longer being relevant.  Similarly, it accepts that if the on-supply route is followed, any input tax that the trustee incurs on services it uses to make the onward taxable supply to the employer will be deductible, with the concept of "dual use" (again) no longer being relevant.

Administration costs: under the new approach, it appears that the generous concessionary treatment for administration costs no longer applies. This means that, for input tax deductions to be available to the employer, it may no longer be possible for service providers to simply invoice it.  If this is the case, it is likely to be necessary for the employer to contract directly with the supplier (if that is possible) or to follow either the VAT grouping or on-supply routes, referred to above, to optimise input tax recovery for administration costs.

The guidance no longer refers to the tripartite contracts route, and so it may be that HMRC no longer considers that such an approach is available to improve an employer's VAT recovery position.

Schemes that are using, or have used, the VAT grouping or on-supply routes

As the dual use concept has been abolished, the benefit of either of these routes will have increased. As it seems that HMRC is open to input tax claims for prior periods, employers (in the case of the VAT grouping route) and trustees (in the case of the on-supply route) should act promptly to make claims in relation to management costs for periods in relation to which the four-year lookback period is set to end soon.

For current VAT accounting periods, employers (in the case of the VAT grouping route) and trustees (in the case of the on-supply route) should seek to recover all of the input tax on investment and management costs.

Schemes that are not using the VAT grouping or on-supply routes

Trustees and employers should reconsider the VAT grouping or on-supply routes, given that the benefit of so doing is likely to have significantly increased both for management and administration costs.