VAT recovery on pension investment costs: What’s changed?

HMRC has recently updated its internal guidance for VAT recovery on pension investment costs, marking a significant shift in approach and one that employers and trustees should revisit carefully.

These updates follow HMRC’s policy change announced in Revenue and Customs Brief 4 (2025), with further clarification now reflected in the June 2026 updates to HMRC’s internal manuals. Taken together, these changes represent a move away from the more pragmatic approach previously adopted and a return to a stricter application of VAT principles.

How will the new VAT recovery on pension investment costs impact you?

Historically, HMRC operated a relatively flexible approach to VAT recovery on pension scheme costs:

• Administration costs were generally treated as recoverable by the employer
• Investment management costs were treated as relating to the exempt investment activities of the trustees and therefore not recoverable
• Where costs were combined, a practical 70/30 split was commonly applied

Over time, this evolved into a dual-use approach, where investment costs were seen as benefiting both the employer and the trustees, and VAT recovery was apportioned accordingly.

HMRC has now moved away from this position.

Under the updated guidance:

• The concept of dual use for investment costs has effectively been removed
• VAT recovery now follows the normal rules, focusing on who contracts for and receives the services

This represents a clear shift back to first principles.

Are there opportunities to revisit historic VAT positions?

The updated position does create an opportunity in some cases. HMRC now accepts, in principle, that employers may be able to recover VAT on investment costs in full, subject to normal deduction rules. This could improve recovery where the employer has a stronger recovery profile than the trustees.

However, this sits alongside a clear tightening of the rules:

• Where trustees remain the contracting party (which is often the case), VAT recovery will generally remain with them
• Trustees are likely to have restricted or no recovery, given their activities are typically exempt
• Historic positions based on dual use or flexible invoicing arrangements may no longer be sustainable

HMRC’s guidance also suggests that trustees may be able to recover VAT where they are making onward taxable supplies to the employer, although this will depend heavily on the facts and their own recovery position.

Importantly, this also creates a potential opportunity for employers who have continued to apply a dual-use approach.

Where arrangements already support the employer as the contractual recipient (or can do so with relatively minor changes), there may be scope to:

• Increase VAT recovery going forward, and
• Potentially revisit historic positions, where claims have been restricted more conservatively than required

Therefore, whilst for some this represents a narrowing of recovery, for others it may unlock additional reclaim opportunities, depending on the facts and documentation in place.

Who can recover VAT on pension investment costs?

The key message from HMRC is that VAT recovery must align with the legal supply chain, rather than the perceived economic benefit.

In practice:

• Where the employer contracts for and receives the services, VAT recovery sits with the employer (subject to its own recovery position)
• Where the trustees contract for and receive the services, the right to recover VAT sits with the trustees

Crucially, HMRC has clarified that invoicing alone is not sufficient. Simply addressing invoices to the employer does not determine entitlement to recover VAT – it is the underlying contractual and legal position that is key.

 

What challenges does this create?

In practice, this creates tension between:

• VAT efficiency, and
• governance and regulatory constraints

Trustees will often need to contract directly for investment management services for regulatory reasons. Moving to a fully employer-led structure is therefore not always straightforward or appropriate.

Equally, employers may be reluctant to take on additional costs or contractual obligations purely to maintain VAT recovery.

Now VAT recovery on pension investment costs has changed- What should you do next?

In light of HMRC’s updated position, organisations need to consider how their current structure aligns with the VAT outcome.

Broadly, this involves assessing:

• Whether the employer can be positioned as the recipient of investment services
• Whether a taxable supply from the trustees to the employer can be established
• Whether VAT grouping is available to eliminate VAT leakage between entities

Given the scale of the change, employers and trustees should now:

• Review existing contractual arrangements
• Confirm who the legal recipient of services is
• Assess whether current structures still support the intended VAT recovery outcome
• Identify any opportunity to enhance recovery or mitigate exposure, including revisiting historic treatment where a dual-use approach has been applied
• Consider if a historic reclaim opportunity exists (employers who already carried out restructuring post PPG)

This is an area where historic approaches may no longer hold, and an early review will help manage both risk and opportunity.

Key takeaways

This change is not about VAT recovery disappearing, but about where the right to recover sits.

HMRC has moved away from a pragmatic, outcome-driven approach and is now applying a more structured and legal analysis.

The critical point is that VAT recovery must now align with:

• Who contracts for the services, and
• Who actually receives them

Where trustees sit in the supply chain, organisations must ensure there is either:

• a clear taxable link to the employer, or
• a VAT grouping arrangement

Otherwise, VAT recovery is likely to remain with the trustees,  often resulting in a less efficient overall position.

How AAB Can Help

As VAT advisors, we are here to help you manage this transition and make the most of the opportunity. That includes:

• Reviewing historic costs and preparing retrospective claims
• Assessing and updating PESMs to reflect the new treatment
• Unwinding legacy arrangements like VAT grouping or management services agreements where they are no longer needed
• Supporting trustees in understanding their recovery rights and obligations
• Engaging with HMRC where method changes or clarifications are required

Our VAT specialists work with employers, trustees and advisers to assess current structures, identify VAT recovery risks and explore opportunities to improve recovery where appropriate.

If you’d like to understand how these changes could affect your organisation, our team would be happy to help. Please don’t hesitate to contact Gabrielle Bird, or a member of our VAT team.