HMRC has announced it is to change its policy on the recovery of input tax in relation to the management of pension funds, following a recent ruling by the Court of Justice of the European Union (CJEU) which has established an employer's entitlement to deduct VAT paid on services relating to the administration and management of a defined benefit pension scheme.

The case concerned Fiscale Eenheid PPG Holdings BV cs te Hoogezand (PPG), where the CJEU ruled that an employer that has set up a pension fund that is legally and financially separate can deduct the VAT incurred on administration and pension fund management services, provided that there is a direct and immediate link between the services and the employer's own supplies.

HMRC has traditionally distinguished between costs concerning set up and day to day administration of the scheme and management of the scheme's investments. Input tax on the former was recoverable by the employer, while income tax on the latter was recoverable by the scheme in recognition of the fact that the employer and the pension scheme were legally and financially distinct entities. Where costs for both of these were included on a single invoice, employers could traditionally recover 30% of the VAT charged as related to administration.

In its briefing note, HMRC states that this 70/30 split has been withdrawn with effect from 3 February 2014. There will be a six-month transition period allowing businesses affected by the change to make alternative arrangements, and the note also indicates that HMRC does not intend to take any retrospective action against businesses that used this breakdown before 3 February 2014.

Pauline Hawkes-Bunyan, Deloitte VAT partner, said: 'Today's Brief is significant and could affect all employers with trust based pension schemes. Employers should review the VAT recovery arrangements currently in place for pension fund management services (administration and investment related) provided to trust based schemes. This will allow them to see whether claims should be submitted for under-recovered VAT and for arrangements in the future. Today's decision will also provide greater clarity for those who have already submitted claims.'

However, Darren Mellor-Clark, partner at law firm Pinsent Masons, says the brief does not make the situation clear about the position HMRC now expects businesses to follow, and there is some uncertainty about how employers are to demonstrate there is a 'direct and immediate link with taxable supplies of goods or services made by the employer', which would entitle them to a refund on VAT paid.

'It may be implied from the rest of the brief that HMRC expects input tax in relation to investment management services only to be recoverable by the scheme, unless they are also accompanied by some administration. However, the position as regards who should recover input tax in relation to administration is not explicitly made clear. Businesses would be prudent to still consider, and perhaps take advice, as to whether they may make additional claims for input tax in relation to investment management costs using the decision in the PPG case,' Mellor-Clark said.