A narrowing path: HMRC’s latest change to VAT recovery for DB pension schemes

CMS’s article last year reported on welcome changes to HMRC’s approach to input VAT recovery for DB pension fund management costs. On 4 June 2026, HMRC made further unexpected changes to its published practice on this matter, which now appears to constrain the recovery position. 

What was previous HMRC policy?

HMRC confirmed on 18 June 2025 that all input VAT incurred on both administration and investment services relating to DB pension funds can be seen as the employer’s and deductible by the employer, subject to normal rules.  HMRC accepted such potentially 100% input VAT recovery provided either (i) the trustees are VAT registered, engage service providers directly, contract with the employer for operating the scheme and on-charge these costs and issue valid VAT invoices to the employer (often referenced as an “on-charging arrangement”); or (ii) there is a VAT group in place, of which both the trustee and the employer are members and a valid VAT invoice is issued to the VAT group by service providers.

The policy change from 18 June 2025 did not appear to switch off the pre-existing but more limited input VAT recovery rights (ie for administration services) for structures where the trustees contract with service providers, but VAT invoices are issued by service providers to sponsoring employers.

As part of the June 2025 announcement, further HMRC guidance was promised to be published in autumn 2025 to explain the rationale for the change in policy. However, such HMRC guidance never materialised.

What is the new HMRC policy?

From an unexpected HMRC manual update on 4 June 2026, it appears HMRC now takes the view that employers can only recover input VAT included in an invoice issued to them by service providers, where the employer directly contracts and pays that service provider.  

Where the employer is not able directly to contract and pay for the services in a way which permits VAT recovery, going forward there appear to be only two situations that allow an employer to recover input VAT incurred on the administration and investment services of a DB pension scheme.  Input VAT recovery by employers appears to remain available only where: (i) the “on-charging arrangement” noted above is put in place, including trustee VAT registration, and the employer holds valid VAT invoices issued to it by the trustee or (ii) there is a VAT group in place including both the trustee and the employer.  Trustees may not favour VAT grouping arrangements, given that under VAT law each member of a VAT group is liable for all liabilities to HMRC of the entire VAT group. 

HMRC also restates in the update that, to be able to recover input VAT under an invoice issued to the employer, payment of the invoice must be made by the employer.  An agreement to make contributions to the scheme does not constitute payment even where those contributions include an allowance for the scheme’s expenses. If an employer now wishes to pay the invoices direct, this may require amendments to the pre-existing funding arrangement with trustees and possibly changes to a pension scheme’s governing rules. 

In the manual update, there is an unclear reference to HMRC accepting the employer has paid for the service where that amount is “deducted from the pension pot”, but this reference appears to be inconsistent with the rest of the update and it is difficult to see how an employer can be said to have paid an invoice when the money comes from the pension scheme assets controlled by the trustees. 

In theory a tripartite contract could be used – with both the employer and the trustee contracting with the supplier and the employer being responsible for payment of the supplier’s fees. The 4 June HMRC update does not address input VAT recovery using this structure. However, HMRC’s standard approach to VAT is that recovery is only permitted by the entity who receives the services under the contract.  For many of the pension scheme services in scope of this change, it is difficult to see how the employer could be said to be receiving the services as they will relate to advice and supplies which the trustee needs to operate the pension scheme and, in some cases, an adviser would have conflict of duty concerns if the employer was to receive their services.

Questions arising from the HMRC update

The HMRC update raises many questions, which for the time being remain unanswered by HMRC, for example:

• should employers review and correct VAT returns of the last four years, where they recovered input VAT in invoices issued to them but with respect to contracts with service providers made by scheme trustees?  In the 18 June 2025 HMRC policy paper reference was made to reviewing the last four years.
• Does the new practice apply immediately from 4 June 2026? What approach should employers take with respect to VAT periods that straddle 4 June 2026? 
• Do tripartite arrangements remain viable?

CMS Comment

HMRC’s previous guidance clearly stated employers could recover input VAT on scheme administration services where the trustee contracted for the services so long the employer held a valid VAT invoice issued to it by the service provider.  Following the 4 June 2026 update, HMRC’s view appears to be that input VAT recovery in this structure will be unavailable. Input VAT recovery by employers will only be available in the “on-charging” and VAT grouping structures.  Given the liability challenges of VAT grouping, the “on-charging arrangement” appears to emerge as the clear winner from the standpoint of input VAT recovery by employers.  

We recommend employers now review their current contractual and invoicing arrangements, and consider implementing the “on-charging” model if not already done so, which should increase input VAT recovery going forward.

For further information please contact the authors of this article or your usual CMS tax or pensions contact.