UK Pensions: HMRC announcement creates opportunity to increase VAT recovery on pension investment costs

HMRC have announced, in a change from their previous policy, that they will now allow employers of defined benefit pension schemes to recover up to 100% of VAT on pension scheme investment costs (“Investment VAT”), if particular structures are adopted.

We expect that only a small number of employers and pension scheme trustees will already have one of these relevant structures in place. If they do, they may be able to make substantial reclaims from HMRC going back up to 4 years and will likely be able to recover additional Investment VAT going forward. Employers and pension scheme trustees that do not have these structures currently in place, should consider implementing such a structure to maximise recovery going forward.

Relevant structures

The structures to which this applies are as follows:

• VAT grouping between the employer and the scheme trustee – see paragraph 1 of the “additional detail” section below;
• contractual arrangements for the pension scheme trustee to make a supply to the employer of running the pension scheme and managing its investments, for which the pension scheme trustee charges a fee plus VAT – see paragraph 2 of the “additional detail” section below; and
• (probably) “paymaster” arrangements where the scheme provides pensions for employees of multiple employers and one entity (an employer or the pension scheme trustee) acts as ‘paymaster' and recharges each of the employers their proportionate share of costs – see paragraph 3 of the “additional detail” section below.

We expect that in most cases a contractual arrangement or, where relevant, a “paymaster” arrangement will be preferable to VAT grouping. More details on all of this are set out below under the heading “additional detail”.

Steps to take now if not currently using any of these structures

The HMRC announcement is, unfortunately, brief and also vague in a number of places.  HMRC have said they will publish further clarifications by "Autumn 2025".  In light of this, most employers and pension scheme trustees will be well advised to wait until this clarification arrives before implementing changes to their structure.

In the meantime, however, employers and pension scheme trustees can and should consider whether changing their structure would be beneficial (including calculating the potential VAT savings) and practicable having regard to their current arrangements.  This will allow them to be as ready as possible to make changes when HMRC provide further details.

Steps to take now if already using one of the structures

Where employers and pension scheme trustees already have this type of structure in place, they should consider whether they can make reclaims to recover a higher proportion of the Investment VAT incurred in the previous 4 years.  A sensible step would be to identify any unrecovered Investment VAT and locate the relevant invoices.  For taxpayers making VAT returns based on calendar quarters, the next filing deadline is 30 September 2025.  This appears some way away but will come quickly.

If they have a personalised agreement with HMRC on how VAT is recovered, known as a PESM, they should also consider whether this should be modified.

Additional detail

Background

The ability of employers to recover Investment VAT in respect of their defined benefit pension schemes has been a contentious and developing area for over 10 years, since HMRC first reacted to the CJEU judgment in the PPG¹ case.

After significant ups and downs, HMRC settled on a position that employers would be able to recover Investment VAT if the employer was a party to the contract for the services and paid for them (including, if a number of restrictive conditions were met, where “tripartite” contracts were used to achieve this), or, recognising that this first option would in many cases be impractical, if either the employer and the pension scheme trustee were members of the same VAT group, or the pension scheme trustee made a supply to the employer of running the pension scheme and managing its investments, for which the trustee charged a fee plus VAT.

Where of these two structures was used, however, HMRC restricted the extent to which the employer could recover the Investment VAT, because HMRC saw the costs as linked to both the employer's business and the investment transactions of the scheme.  The employer using one of these structures could recover only a fair and reasonable proportion of the Investment VAT (the proportion had to be agreed with HMRC).

New policy

VAT groups

Where the employer and the pension scheme trustee are members of the same VAT group, HMRC will now treat all of the Investment VAT as the employer's VAT.  This should allow an increased proportion of the Investment VAT to be recovered.  Where the employer has a fully VATable business (i.e. one not making VAT-exempt supplies) potentially 100% will be recoverable, depending on the personalised VAT recovery method (“PESM”) that the VAT group has agreed (or now modifies) with HMRC.

Pension scheme trustee charging the employer for services

Similarly, where a pension scheme trustee charges the employer a fee plus VAT for running the scheme and for managing its investments, HMRC will now treat all of the Investment VAT as the employer's VAT, presumably (though not stated) relying on the assumption that the pension scheme trustee will recharge all of the investment costs to the employer.  HMRC state that the pension scheme trustee in this case “will also be able to deduct input tax incurred for the purpose of providing those services, provided they are VAT-registered.  Any deductions by the pension scheme trustees will be subject to normal deduction rules.” We expect that pension scheme trustees not currently registered for VAT would have to register in order to take advantage of this structure.  This would involve some process both initially and going forward but, subject to any scheme-specific issues, if the VAT at stake is material we would expect the benefits to outweigh the costs.

“Paymaster arrangements”

Paymaster arrangements are not mentioned in HMRC's announcement.  However, our understanding is that HMRC have, up to now, taken a similar approach to that described above for the other two structures, in that they have only allowed a proportion of the Investment VAT to be recharged to the employers through the paymaster and recovered by them.  They have seen the Investment VAT as linked to both the employer businesses and the investment transactions of the scheme. The new policy would appear, as a matter of principle, equally applicable to these arrangements.

Next steps

We would be happy to assist employers and pension scheme trustees with determining how to react to HMRC's change of policy. Please reach out to any of the listed contacts.

Authored by the Pensions and Tax teams.