Brushing up on pension contributions

Provided that a contribution to a registered pension scheme meets the test of ‘wholly and exclusively for the purposes of the trade’ it will be an allowable deduction for corporation tax purposes (s54 Corporation Tax Act 2009).

Timing

The deduction for the employers’ contributions to registered pension schemes is for the period of account in which it is paid by the employer, and for no other period.

In practice, as the accounting treatment is not followed for tax purposes, this means that an employer’s tax computation is adjusted to:

• add back the deduction for the pension scheme contributions shown in the profit & loss account
• give a deduction for contributions to registered pension schemes on a ‘paid’ basis.

There are two instances when the contribution is not accounted on the ‘paid’ basis – this is when ‘spreading relief for substantial pension contributions’ will apply or where the employer has ceased trading:

a) Spreading is where the relief due to an employer on the making of a contribution to a registered pension scheme is not given entirely in the chargeable period in which the payment is made. Instead, part of the relief due is spread forward into future periods. Spreading of deductions will be required where there is an increase over 210% in the level of employer contributions paid from one period to the next, unless the increase is below £500,000. The legislation is written so that where no contribution was paid in the previous chargeable period, for example if an employer has only just set up a pension scheme, tax relief on contributions in the current chargeable period will not be spread.

Only tax relief on an ‘excess’ contribution of £500,000 or more will be spread. The length of time the tax relief will be spread over depends on the size of the excess. Read further guidance.

b) Where an employer who has ceased trading has to make a payment into a registered pension scheme to satisfy a liability crystallising under s75 of the Pension Act 1995, the payment is treated as being made on the last day of trading and is deductible in arriving at the profits for the final period of trading.

Pension contribution made on behalf of a controlling director

Employer’s contribution made in respect of a controlling director-shareholder or a member of their family may not be deductible if it is viewed as being made for a non-trade purpose.

One situation where all or part of a contribution may not have been paid wholly and exclusively for the purposes of the trade is where the level of the remuneration package is excessive for the value of the work undertaken by that individual for the employer. Consideration should be given to the amount of the overall remuneration package, not simply the amount of the pension contribution.

HMRC has stated that, in its opinion, the contributions are paid wholly and exclusively for the purposes of the trade where the remuneration package paid in respect of a director of a close company, or an employee who is a close relative or friend of the director or proprietor (where the business is unincorporated) is comparable with that paid to unconnected employees performing duties of similar value.

Pension contribution and cessation

Contributions made as part of the arrangements for going out of business – in particular where there is no pre-existing contractual obligation to make such a contribution – are not considered as meeting the ‘wholly and exclusively for the purpose of the trade’ test.

In the case of CIR v Anglo Brewing Co Ltd [1925] 12 TC 803, the company decided to close down its business. In the past, the company had granted pensions to employees on their retirement. The company promised to treat its present employees with equal generosity. The company therefore agreed pension amounts (which were later commuted for lump sums) and compensation payments. The company claimed the costs as a deduction in computing its profits. The High Court took the view that the payments were made for the purpose of winding up the company and that no deduction was due for the pensions or the compensation.

There is now a statutory relief for redundancy payments but the principle of the decision, that payments to go out of business are not allowed, remains valid.

Payments made to satisfy a liability under s75 of the Pension Act 1995, although often triggered by a cessation, are distinct from payments made for the purpose of going out of business; such a payment is allowed and it treated as being made on the last day of trading.

The annual allowance charge

The annual allowance (AA) is the most a person can pay into their pension pots in a tax year (6 April to 5 April) before a tax charge will arise. Where pension contributions for a tax year exceed the AA, the excess is subject to charge at the persons marginal rate of income tax. The available AA is also tapered by £1 for each £2 adjusted income exceeds a defined limit.

From 6 April 2023 the AA increased from £40,000 to £60,000. The adjusted income limit increased from £240,000 to £260,000 and, where tapering applies to reduce the AA for an individual, the minimum tapered AA is £10,000 (up from £4,000).

The annual allowance limits the total input into a pension scheme and includes both employee and (employer) company contributions.

In computing the AA charge, members are able to bring forward any unused relief for the three previous years (provided they were a member of a pension scheme in those years). For example, any unused AAs from any of the past three tax years can be used in addition to your current year AA limit enabling the increase in the maximum tax-relieved pension contributions for the current year.

Companies that are planning to make substantial contributions will therefore need to consider the potential annual allowance income tax charge that may arise in the member’s hands.

HMRC does not tax anyone for going over their annual allowance in a tax year if they:

• retired and took all their pension pots because of serious ill health
• died.

Lifetime allowance

The lifetime allowance (LTA) is the maximum savings an individual can hold in a pension fund without facing penal tax charges when taking pension benefits.

From 6 April 2023 onwards, the LTA charge no longer applies in terms of calculating tax due on any excess pension savings.

Importantly, the existing LTA limit of £1.073m will continue to apply for the purpose of capping the 25% tax-free lump sum. This means the maximum tax-free lump sum for the majority will stay at £268,275. Nonetheless, if an individual holds pension protection, the maximum lump sum is 25% of the protected amount.

From 6 April 2023 if the excess pension savings is taken out in the form of a lump sum, it will simply be subject to income tax at the individual’s marginal rate.

Pension fund and inheritance tax

In cases where pension funds have not been withdrawn at the time of an individual’s death, the entire value is expected to transfer to the nominated beneficiaries without an immediate inheritance tax charge.

If the individual passes away before reaching the age of 75, no tax charges, whether in the form of income tax or inheritance tax, will apply to the beneficiaries accessing the funds.

However, if the individual dies after the age of 75, the beneficiaries will be subject to income tax based on their marginal rate when they choose to withdraw the funds.