It is therefore recommending that pension funds jointly finance a legal challenge to HMRC’s view that VAT should be charged on these services.

NAPF Chief Executive, Joanne Segars, explained that:

“After the clarification from the European Court of Justice, there is a strong case that pension funds should not have to pay VAT on investment management services. Instead, they would be able to use these savings to benefit their members."

She went on to add that: "Litigation is never without risk and it would be expensive for any one pension fund to finance a legal challenge on its own. But if a number of funds agree to share the costs, they could get their money back several times over."

“Ultimately, it is for pension funds to decide whether they want to challenge HMRC. If we get enough interest from our members, we will co-ordinate a case,” Ms. Segers concluded.

In June 2007, the European Court of Justice (ECJ) clarified what the VAT Directive meant when it stated that the “management of special investment funds as defined by Member States” should be exempt from VAT.

The judgment dealt with questions arising from a challenge to UK law under which VAT was charged on investment management services supplied to Investment Trust Companies (ITCs), but not on similar services supplied to Authorised Unit Trusts, Open Ended Investment Companies and other single property trust-based schemes.

This case was brought jointly by the JPMorgan Fleming Claverhouse Investment Trust plc and The Association of Investment Companies, against HM Revenue and Customs.

In November 2007, HMRC conceded that investment management services supplied to ITCs should be exempt. However, it continues to maintain that the ECJ judgment does not apply to anything other than ITCs. This means that a fresh legal challenge would be required before pension funds could get back any of the VAT they have paid.

The Association announced on Friday that:

"The NAPF, having taken advice, believes that occupational pension funds also qualify to be treated as Special Investment Funds and that current UK VAT law violates the principle of fiscal neutrality which underpins the VAT Directive."

"Under current rules, any payments to pension funds following a successful legal challenge would be backdated to three years before the date when their managers first submitted a claim. The NAPF is therefore encouraging occupational pension funds to talk to their investment managers about submitting protective claims if they have not done so already."

"The issue affects pension funds which have segregated investments controlled through asset managers. Investment management services provided through pooled funds and insurance wrappers are already exempt."

"In practice, this means that defined contribution schemes will not usually pay VAT on investment management services. Some defined benefit schemes also structure their investments in this way. Local Authority funds will generally be able to recover all of the VAT charged to them, including that on investment management fees."

It concluded: "The NAPF has been advised by KMPG and PwC on this issue and has taken Counsels’ opinion."