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Wheels: specified investment funds

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IIn Wheels Common Investment Fund Trustees Ltd and others (Case C-424/11), the CJEU ruled that defined benefit trust-based occupational pension schemes (OPS) do not qualify as ‘special investment funds’. They cannot be regarded as collective investment undertakings under the UCITS Directive, nor are they sufficiently similar to be in competition with them. Key factors which led to this finding are that OPS are not open to the public, that they do not contain any element of investment risk for members, and that contributions from employers are made as a means of complying with their legal obligations toward employees.

The decision of the CJEU in Wheels was delivered on 7 March 2013. It is the latest in a line of cases in which the CJEU has considered the scope of the exemption prescribed by article 135(1)(g) of Council Directive 2006/112/EC, formerly article 13B(d)(6) of Council Directive 77/388/EEC (‘the exemption’): ‘the management of special investment funds as defined by Member States’.


Claverhouse: In 2007 the European Court of Justice (as it then was) released its decision in JP Morgan Fleming Claverhouse Investment Trust PLC v HMRC (C-363/05).

Claverhouse looked at the application of the exemption to supplies of management services to investment trust companies (ITCs), the crux of the issue being whether ITCs (‘closed-ended funds’) fell within the meaning of ‘special investment funds’ (SIFs); it being noted that AUTs and OEICs (open-ended funds, falling within the ambit of the UCITS Directive), expressly benefited from exemption under VATA 1994 Sch 9 Group 5 Items 9 and 10.

On a reference from the VAT & Duties Tribunal, the court observed that whilst art 13B(d)(6) gave the task of defining the meaning of SIFs to the Member States, it did not permit them to select certain funds in their territory and grant them exemption and exclude other funds from that exemption. In exercising the power to define the funds which meet the definition of SIFs, the Member State must observe: (i) the objective pursued by the provision, namely to facilitate investment in securities by way of investment undertakings by excluding the cost of VAT; and (ii) the principle of fiscal neutrality, which precludes economic operators carrying out the same transactions (or similar transactions which are in competition with each other) from being treated differently for VAT purposes, and which includes the principle of elimination of distortion in competition where there is such differing treatment.

The court concluded that to interpret art 13B(d)(6) in a manner which exempted the management of open-ended funds, but not that of closed-ended funds, offended the principle of fiscal neutrality, hence the phrase SIFs was capable of including closed-ended funds such as ITCs. It was the outcome of this case which led commentators to consider whether the exemption should be applied more widely, notably to include pension funds.

Wheels: The proceedings addressed the issue of whether management services provided to and for the benefit of defined benefit occupational pension schemes (OPS) should also fall within the exemption.

The proceedings were commenced in the First-tier Tribunal, which referred essentially three questions to the CJEU: (i) whether the phrase SIFs was capable of including OPS with defined benefit characteristics established by an employer that are intended to provide pension benefits to employees, and/or a common investment fund in which the assets of several of such schemes are pooled for investment purposes; (ii) whether a pooled vehicle comprised of defined benefit pension funds (such as in Wheels) should similarly fall under exemption in light of the features of the funds from which they are constructed (this second point was accompanied by a list of the key features of the funds in issue); and (iii) whether Member States were entitled to define SIFs in such a way so as to exclude OPS funds and pooled funds such as in Wheels and, finally, in determining what qualified as a SIFs, to what extent Member States must consider (a) the features of the fund (e.g. defined benefit, etc.) and (b) the extent to which the fund competes and is similar to existing SIFs.

The essence of the appellants’ case was that the fund management services provided to OPS were the same or sufficiently similar to funds that, it is common ground, are SIFs. To that end, pension funds were no different to AUTs, OEICs or ITCs, in that investors’ contributions are pooled and invested for the benefit of its members, with the additional benefits of achieving a wider diversity of investment and spreading risk. The UK (supported by the Commission) contended that OPS were not similar to and in competition with other investment products which are recognised as SIFs, since defined benefit OPS schemes provide guaranteed benefits that are based on a member’s final salary, scheme members do not bear any risk in relation to the investment performance of the underlying assets and OPS are not available to the public at large.

The decision of the CJEU

The court dispensed with the need for a written opinion from the advocate general and delivered its judgment on 7 March 2013. In forming its conclusions it essentially repeated and adopted the principles identified and applied in Claverhouse. With this in mind, the court proceeded to undertake a comparison of the circumstances and characteristics pertaining to defined benefit OPS and those pertaining to funds that constituted SIFs within the meaning of the exemption. It observed that funds which constitute undertakings for collective investments in transferable securities within the meaning of the UCITS Directive (85/611/EEC as amended), such as AUTs and OEICs, are SIFs (Deutsche Bank [2012] ECR I-0000, para 32), have as their sole objective the collective investment in transferable securities of capital raised from the public, and offer an alternative to direct investment for individual investors. AUTs and OEICs are, therefore, in accordance with the objective pursued by the exemption. It was noted that it was also possible for funds to fall within the meaning of SIFs albeit not falling within the ambit of the UCITS Directive, provided they displayed identical characteristics to such funds and carried out the same transactions, or at least displayed characteristics sufficiently comparable.

Turning to defined benefit OPS, the court concluded that they could not be regarded as collective investment undertakings within the meaning of the UCITS Directive. Nor are they sufficiently similar to be in competition with them. The court gave a number of reasons for reaching these conclusions:

  • OPS were not open to the public in general – they were only open to employees as an employment-related benefit. In consequence, they were not identical to investment vehicles that constitute SIFs within the exemption.
  • OPS do not meet the same needs as collective investment schemes falling under the UCITS Directive. Unlike private investors investing in UCITS vehicles, members of defined benefit OPS do not bear any investment risk as the pension (i.e. the return) received is defined in advance on the basis of length of service and salary. In contrast, persons purchasing units in a collective investment undertaking under the UCITS Directive receive a return which is dependent on the performance of the investments made by the managers; and
  • Finally, employers contributing to OPS should not be considered to be standing in the shoes of private investors in a UCITS fund when they make contributions to OPS. They are in a different position to private investors in a collective investment undertaking, for even though they bear the financial consequences of the investments made by the schemes managers, their contributions are made as a means of complying with their legal obligations to employees.

Why it matters

The judgment is helpful as it provides further clarity in relation to the application of the exemption. However, its conclusions will be disappointing to those in the pension fund industry. There will be no repayments of VAT for defined benefit OPS on the back of Wheels.

In spite of the CJEU reaching a definitive conclusion, the judgment has not provided clarity for all OPS in that it focused on the VAT treatment of management services provided to OPS with defined benefit characteristics, rather than all types of OPS. Consequently, there remains uncertainty in respect of defined contribution OPS in particular. In view of the reasoning of the court for finding that defined benefit OPS are not like UCITS funds and therefore are not SIFs for the purposes of the exemption, it does not necessarily follow that defined contribution OPS are not SIFs. This issue should soon be addressed by the court in the ATP Pension Services AS (C-464/12) (ATP). However, even if the CJEU reaches a similar conclusion in respect of defined contribution pension schemes and finds they are not SIFs, all is not lost, as the referred questions in ATP also ask whether the services in question in the case are capable of qualifying for VAT exemption as transactions concerning payments or, failing that, operation of a deposit/savings account under art 13B(d)(3) of Council Directive 2006/112/EC. Notwithstanding the above, it is also worth noting of course that many defined contribution OPS in the UK are set up as contracts of insurance with life insurers thus benefiting from the insurance VAT exemption in any event.

There is then also the matter of who can recover VAT incurred on pension-related costs.

In respect of the latter, PPG Holdings (C-26/12) (a reference from the Netherlands) should determine whether the pension fund or the sponsoring employer is entitled to recover VAT incurred on pension related costs (including services provided by investment managers). Current UK practice dictates that the contributing employer is entitled to seek to recover VAT incurred on administrative costs, whilst the trustee can seek to recover VAT in investment-related costs. Should the CJEU determine that the sponsoring employer is entitled to recover VAT on investment-related costs, then from a pure VAT perspective, this could possibly present an opportunity to reduce the amount of irrecoverable VAT incurred in connection with pension arrangements in respect of the majority of OPS. The reason for this is that the majority of sponsoring employers are entitled to recover more VAT than their pension schemes. This could be good news in principle, although the infrastructure and legal framework for pension provision in the Netherlands is different from that in the UK; hence the judgment will require careful scrutiny.

Finally, readers will be aware that the EU Commission is reviewing the VAT treatment of financial services. Current draft legislative proposals treat the management of pension funds as exempt from VAT. It will be interesting to see whether the Wheels judgment leads to changes in the draft proposals.

Howard Sharkett is a solicitor (non-practising) and senior manager within KPMG LLP’s legal services team

Richard Louden is a chartered tax adviser and senior manager within KPMG LLP’s financial services indirect tax team