United Biscuits: VAT exemption for non-insurers

The VAT treatment of investment management fees incurred by defined benefit pension funds has once again been considered by the High Court. On this occasion, in United Biscuits, the issue at stake was whether investment management services provided by non-insurers should benefit from the exempt treatment for such services provided by insurers. The court rejected this argument. The policy in this area has been under review for some time. In April 2017, HMRC announced that the policy of allowing insurers to exempt the provision of insurance management services would be withdrawn with effect from April 2019. HMRC is expected to publish a comprehensive review of the VAT treatment of pension funds in the near future and this will hopefully bring clarity and consistency to the treatment of funds.

The recent decision of the High Court, in United Biscuits [2017] EWHC 2895, has drawn together two themes that have engaged the courts in VAT litigation in recent years. The first relates to whether investment management services supplied to pension funds and other investors is exempt from VAT. The second relates to whether a fund receiving investment management services (customer) from an investment manager (supplier) can recover VAT mistakenly paid for the service from the supplier or directly from HMRC.

The case involved a reclaim of VAT paid by the trustees of a defined benefit contribution scheme to investment managers. The main focus of recent litigation has been directed at whether investment management services fell to be treated as exempt financial services within VATA 1994 Sch 9 Group 5 item 9.

Item 9 is the domestic legislation implementing the Prime VAT Directive provision which exempts investment management services provided to special investment funds (SIFs).

Two CJEU cases considered this question in relation to pension funds. ATP Pension Service (Case C-464/12) decided that a defined contribution schemes could be treated as a SIF. However, Wheels Common Investment Fund Trustees and Others (Case C-424/11) decided that a defined benefit scheme could not be regarded as a SIF. It might have been thought that this had resolved the treatment of investment management services in the world of pensions.

The trustees of the United Biscuits pension fund (‘the trustees’) found a different twist on the issue, arguing that investment management services were an exempt supply of insurance within VATA 1994 Sch 9 Group 2 item 1. Although it might seem a surprising result, the argument picks up on a longstanding HMRC practice. HMRC had treated investment management services provided by authorised insurers as exempt but had regarded investment services provided by non-insurers as standard rated. The source of this practice lays in the terms of the directives and, in particular, the First Life Directive (First Council Directive (direct life insurance) 79/267/EEC). This defined what constitutes insurance for regulatory purposes and requires authorised insurance companies only to carry on insurance business. Article 1(2) provides for certain operations to be subject to supervision and includes within that class of operations management of investments on behalf of group pension funds. It is understood this was the basis on which HMRC treated investment management services provided to insurance companies as falling within the scope of the insurance exemption.

The trustees’ claim related to insurance management services provided by non-insurers. The main pillar of their case was that the meaning of insurance had to be read across from the First Life Directive into the VAT Directives, the Sixth Directive and its successor the Prime VAT Directive. HMRC’s argument was that investment management provided to pension funds was not insurance, as the term was ordinarily understood. Insurance involves the presence of a risk which will result in payment from the insurer if the risk materialises. Both arguments were available because neither the VAT directives nor UK domestic legislation define insurance.

Warren J rejected the trustees’ argument. Investment management of pension funds did not fall within the ordinary meaning of insurance, as explained in the UK case Card Protection Plan Ltd v CCE [2001] UKHL 4 and the CJEU case Försäkringsaktiebolaget Skandia (publ) (Case C-240/99). The explanation for including investment management within the First Life Directive was not that it constituted insurance ‘proper’, but that it allowed an authorised insurer to carry on that activity as a subsidiary activity to its insurance activities. Whilst, as a general rule, proposition terms used in one directive should have the same meaning in other directives, in this case it would be an odd proposition that the meaning of the term insurance for the purposes of a VAT directive should be changed by the terms of a later directive which was directed only at the regulation of insurance.

For the trustees, establishing exempt treatment of investment management services was only the first step in seeking to recover the VAT charged on the services they had received. The issue was whether the trustees only had a contractual remedy against the suppliers or whether they had a direct remedy against HMRC.

The starting point from a European law perspective is a decision by the CJEU in Amministrazione delle Finanze v SpA San Giorgio (Case C-199/92) (San Giorgio). This established that where tax had been levied contrary to EU law, the taxpayer had a directly effective right to repayment of that tax as a matter of EU law. However, it also established that it is a matter of domestic law as to how that right should be given effect. There were, however, two important qualifications in relation to domestic law. The first is that domestic law should not be framed in such a way as to render the exercise of such rights virtually impossible. The second is that in the context of VAT, domestic law can restrict the ability of a taxpayer to recover overpaid tax where this would result in the unjust enrichment of the taxpayer, because the overpaid tax has been passed on to the supplier’s customers. Typically, in the case of VAT, tax charged on a supply will be added to the bill charged to customers. In that case, domestic law can stipulate that any VAT recovered by the supplier must be passed on to the customer.

UK domestic law gives effect to a right to recover overpaid VAT through the mechanism of VATA 1994 s 80. This provides that where VAT has been overpaid, HMRC shall give credit to the taxpayer for that overpaid amount; and, to the extent the credit exceeds the taxpayer’s liability for a relevant period, HMRC will pay the excess to the taxpayer. Section 80 contains two important qualifications. First, VAT is only repayable to the extent that a claim is made within four years. Second, the right to repayment under s 80 is the only remedy of the taxpayer and any other remedy of the taxpayer under restitutionary principles is excluded.

The provisions of s 80 have been subject to exhaustive litigation in the UK courts and the CJEU. The position might be thought to have finally been laid to rest by the decision of the Supreme Court in Investment Trust Companies (in liquidation) v HMRC [2017] UKSC 29 (ITC). This was a case which also concerned the VAT treatment of the costs of investment management, but in the context of whether investment trusts (closed ended investment funds) were SIFs. It was held by the CJEU, in JP Morgan Fleming Claverhouse Investment Trust Plc (Case C-363/05), that they were; and the litigation in ITC was concerned with what remedies followed on from that.

A critical question was whether the investment trusts had a direct restitutionary claim against HMRC or, as it is usually put, whether they had a San Giorgio ‘right’. Lord Reed rejected this argument on the basis that there was no single transfer of value from the investment trusts to HMRC; rather, there was a two-step process. The investment trusts paid VAT to the managers. That VAT was paid under a mistake of law and accordingly the managers had a restitutionary claim against the managers. The managers in turn had a claim against HMRC under s 80. When these steps were taken together, there was an effective remedy under domestic law. No separate restitutionary claim was required as between HMRC and the investment trusts to give them an effective San Giorgio right; domestic law was sufficient.

The difficulty from the taxpayer’s perspective lies in the four year time limit. As EU law based claims for repayment of direct and indirect taxes flourished, it became clear that the expense to public funds was potentially vast, so the government introduced a four year time limit on claims to recover VAT paid under mistake. Although itself subject to litigation in the CJEU (in Fleming), it is now clear that a time limit may be imposed without breaching the requirement in San Giorgio that domestic law must not make the right to recover overpaid tax virtually impossible to exercise (Leeds City Council v HMRC [2016] STC 2256). The two step approach to an effective San Giorgio right depends on the taxpayer having a restitutionary claim against the supplier for unjust enrichment in respect of payments made under a mistake of law. If the supplier is unable to recover the VAT from HMRC, it would seem that the supplier has a defence to that claim under a defence of change of position. Put simply, the supplier has not been unjustly enriched if he has paid away the monies paid by mistake to HMRC and cannot recover that money under a claim under VATA 1994 s 80.

Faced with these difficulties, the trustees developed an ingenious argument to substantiate a claim to recover the VAT. The starting point was to establish a direct claim on San Giorgio principles, distinct from the domestic law claim as identified under the ITC litigation. The first step on the way to this result was to argue that the trustees did not in fact have a claim in restitution against the suppliers at all; a somewhat counter-intuitive argument for the trustees to raise.

This step turned on the terms of the contracts with the suppliers. The fees were to be paid together with VAT ‘if applicable’. The argument ran that this required payment of VAT to be paid in addition to the fees, because at the time of the payment it would not have been known (had the fees in fact been exempt) that VAT was not payable, and the suppliers would not have exercised their rights under s 80. Warren J rejected this construction of the contracts. The same point had been made in the ITC litigation but was not ultimately pursued. This seems to be the right conclusion; the notion that a contract should provide for payment of VAT whether or not it was properly due, without recourse to a remedy for mistake, could only possibly be substantiated by the very clearest of drafting.

If the contract did give rise to a remedy in restitution, then the alternative way to establish a San Giorgio right would be to show that that domestic law remedy was virtually impossible to enforce. The argument here appears to be that the lack of clarity in relation to EU law on the treatment of investment management services, taken together with the time limit in s 80, means the rights under domestic law were impossible to enforce. The taxpayers had remedies, in as much as they could take proceedings in the UK courts and the CJEU to assert their claims. This argument was also rejected.

The final steps in the trustees’ arguments were also addressed, although they did not strictly arise because the argument that there was no restitutionary claim or only an impossible to exercise restitutionary claim had been lost. The trustees fared better on the next of these two steps. Warren J held that if there was no domestic claim in restitution, then there would be a San Giorgio claim to a restitutionary remedy as a matter of EU law, which the provisions of VATA 1994 s 80(7) would not exclude.

The final step in the argument was what, if any, time limit should apply in relation to the San Giorgio right? Was it the normal six year time limit under Limitation Act 1980 s 5 or the four year limit under VATA 1994 s 80? This appears a quite difficult point. The starting premise is that in these circumstances, VATA 1994 s 80(7), which provides that the only remedy for repayment of overpaid VAT is a claim under s 80, has to be disapplied. The question is whether that disapplication should go so far as to strike out the four year time limit. Warren J thought not, but the point seems an arguable one.

Where does this leave us?

HMRC has been wrestling with the VAT treatment of pension funds for some time. A consultation is promised later this year. It is striking that on the primary issue in this case, as to whether investment fund management services provided to pension funds were exempt, HMRC argued that such services were not insurance as that term is generally understood and were not therefore exempt. This runs contrary to the practice at the time the case was heard of treating such services as the provision of exempt insurance services. Warren J in obiter comments plainly seemed to think the exempt treatment of management services by insurers was contrary to the VAT directives. In November 2017, HMRC announced exempt treatment would be withdrawn from April 2019 (Brief 3/2017).

Currently, there is no conformity in the treatment of defined benefit and defined contribution schemes, without any apparent policy reason why this should be the case. Perhaps this is one area where post-Brexit divergence could allow fiscal neutrality by extending exemption to both types of fund. What does seem likely, however, is that further litigation on the scope of rights to recover VAT and restitutionary remedies is likely to continue.

This article by Chris Bates was first published in Tax Journal.