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TaxationWeb by Bob Fraser MBA MA FSFA

Bob Fraser, MBE, MBA, MA, FPFS, TEP of Towry Law Financial Services Ltd outlines HMRC’s approach on the tax deductibility of employer pension contributions post A-Day.There has been much uncertainty as to the approach that HMRC will take, post “A” Day, in respect of employer pension contributions, particularly in respect of director and associated persons contributions.

Draft guidance

HMRC has now issued draft guidance on the HMRC website relating to the applicability of the "wholly and exclusively" provisions to employer contributions to registered pension schemes. This guidance is expected to be formalised by 6th April 06.

The essential points are summarised below.

An employer’s contribution to a Registered Pension Scheme will be allowable for tax relief purposes if it satisfies the "wholly and exclusively" for the purposes of the trade test as set out in section 74(1) of the Income and Corporation Taxes Act 1988 and section 34 of the Income Tax (Trading and Other Income) Act 2005.

HMRC confirms that the payment of a pension contribution is part of the normal costs of employing staff. It will only be disallowable where there is an identifiable non-business purpose for the employer´s decision to make the contribution to a registered scheme, or for the size of the contribution. Examples of non-business purposes are given as:-

- if there is a non-trade purpose for the size of the contribution paid in respect of a controlling director or an employee who is a close friend or relative of the controlling director or proprietor of the business

- Where contributions are paid by a party other than the former employer after a trade has ceased or been sold.

‘Wholly and exclusively?’

HMRC state that they will look to see, when an employer contribution is paid in respect of a controlling director or an employee who is a relative or close friend of the business proprietor or controlling director, if the contribution is the same as that paid for a third party employee in similar circumstances. If it is, then the contribution can be accepted that there is no non-business purpose and the full amount of the contribution can be tax relieved. The guidance illustrates an example in which a small company employs the only shareholder’s spouse. The company pays the spouse a salary of £40,000 and contributes to a registered pension scheme on her behalf. Local Inspector should look for the following evidence to establish whether the contribution to the scheme is paid wholly and exclusively for the purposes of the trade:-

- are there any comparable third party employees? If the spouse works alongside an unrelated third party and they have comparable salaries, pension contributions, terms and conditions, this would indicate there is not a non-trade purpose for paying the pension contribution.

- What is the business purpose if the pension contribution paid on behalf of the spouse is greater than that for an unrelated third party?

- Does the level of the salary reflect the value of the work undertaken by that individual for the employer, or is it artificially low? If so, then it is likely that there is also a non-business purpose for the payment of the pension contributions.

Where the salary is less than the commercial rate and the size of the pension contribution appears to have been inflated, it will need to be established why this has been done and whether any tax or NI planning for the employees was one of the purposes for the size of the pension contribution rather than an incidental benefit arising from it.

If a business is being sold or going out of business and a contribution is made to a registered pension scheme, then the Inspector should clarify the circumstances that prompted the contribution. The Inspector should establish whether there was an undertaking to provide a pension to employees as part of their employment package. Where the contribution is not paid to a pension scheme under an undertaking to provide a pension given to the employees as part of their employment package, the cost may not be allowable if it is not incurred for the purposes of carrying on the business. This decision will depend on why the employer decided to make the contribution when it was under no obligation to do so. If the decision to make the contribution was for the purposes of going out of business, the contribution will not be an allowable deduction. A specific example is given of a company selling its trade and ceasing activity, where in the final period the company makes a substantial payment into a registered pension scheme on behalf of a director. As the pension scheme was not part of the director’s remuneration package the contribution may well be disallowable.

In conclusion, it can be seen that whilst under the old regime there was reasonable clarity about what level of pension contributions was tax relievable, the new regime will require greater consultation with the local Inspector of Taxes before imaginative pension planning can be carried out. This may well inhibit the flexibility that this new regime was seeking to introduce.

February 2006

Bob Fraser MBE, MBA, MA, TEP
Chartered Financial Planner

Towry Law Financial Services Ltd
Office Telephone: 028 2563 8563
Mobile phone: 07769880476
e-mail: bob.fraser@towrylaw.com
Authorised and Regulated by The Financial Services Authority