Pension funds take court action over VAT

Britain's biggest pension funds are to sue the Government for refunds of hundreds of millions of pounds worth of value added tax (VAT) they claim to have been illegally charged on investment management fees.

The National Association of Pension Funds (NAPF) and Wheels Common Investment Fund, an £8bn car industry scheme, unveiled the legal challenge yesterday, following a European Court of Justice ruling last year that the Government was not entitled to charge VAT on the management fees paid by "special investment funds".

If the legal challenge is successful, pension schemes would be entitled to claim back at least £300m in VAT paid over the past three years, but might also be able to apply for refunds of tax paid in previous years. An adverse ruling would cost the Treasury £100m annually in the future.

Joanne Segars, the chief executive of the NAPF, said: "There is a strong case that defined benefit occupational pension funds should be exempt from paying VAT on investment management services – a successful outcome would benefit members in both open and closed defined benefit schemes." The NAPF will argue that defined benefit pension schemes should be treated for tax purposes in the same way as other types of investment fund, many of which do not currently pay VAT in the UK.

Under European Union law, certain investment funds are entitled to claim exemption from VAT on management fees. However, member states are given some latitude to decide which type of funds are covered by the law and the UK had until last year restricted the exemption to unit trusts and open-ended investment companies (Oeics).

In November, the exemption was extended to the investment trust industry, after the Association of Investment Companies successfully challenged its members' exclusion in the European Court of Justice in a case brought together with JP Morgan, the fund manager.

Ms Segars said the same benefits should also be offered to final salary pension schemes which, like investment trusts, unit trusts and Oeics, have segregated investments managed by asset managers. Most other pension schemes already qualify for the VAT exemption, because they typically access investment management through unit trust and Oeic structures, or via insurance products that are also exempt. The NAPF also warned the Government that it had advised individual pension scheme members to instruct their fund managers to claim refunds through the VAT tribunal process administered by HM Revenue & Customs. It said those that had already had such claims rejected should now have their appeals reconsidered alongside the NAPF test case.

Pension schemes' VAT bills are significant because the tax charge is payable at the full 17.5 per cent rate on investment management fees. The NAPF represents pension schemes with about £800bn in assets under management. Under UK tax laws, claims for VAT refunds can be backdated by three years, but the prospect of additional appeals has been raised by a second test case currently being fought by the Association of Investment Companies. It is seeking to have the three-year time limit ruled illegal, paving the way for VAT refund claims dating back to 1991.

However, a spokesman for HMRC said yesterday that it would contest the NAPF's case. He said: "HMRC is still of the view that the ECJ judgment in JP Morgan has no relevance to the treatment of the investment management services supplied to pension funds."