Pension tax legislation defines the only two types of pension contribution (excluding rebates) that can be paid to a registered pension scheme as personal contributions (which will include third party payments) and employer contributions.

Employer contributions are, on the face of it, straightforward. However, there are potentially more complex issues related to things such as:

• the amount of the contribution that can be made,
• who the contribution can be made for
• the tax relief and liability issues.

Many of these issues are interlinked by the legislation and this article looks at some of the more common questions that may occur and the main areas regularly discussed.

It covers the main points of the topic and consequently needs to be viewed as only a guide. There may be further details that may affect funding decisions but occur infrequently.

There is no defined maximum contribution an employer can pay. As long as it can be reasonably proved the contribution is ‘wholly and exclusively’ for the purposes of the UK business, the tax relief is not restricted on the contribution an employer makes on behalf of the employee.

Any contribution made over the annual allowance will create an annual allowance charge which will subject the member to a tax charge. This charge will be levied on the member and will be at a rate commensurate with the highest rate(s) of income tax the client pays. This can cause potential problems for the member as the contribution that has been paid is a legitimate contribution and cannot be refunded, so the member will have to find the money for the charge. Clauses in the Finance Bill will require scheme administrators to provide a service, whereby for tax charges in excess of £2,000 a member can request that benefits under the scheme be reduced to meet the tax liability.

The only exceptions to an annual allowance charge being applied are where a member dies, retires early under serious ill-health provisions, or whose health is such that it meets the major ill-health conditions contained within the 2011 Finance Bill.

A member earns a salary of £70,000 but makes no personal contributions towards pension provision. The employer recognises the contribution of this employee and contributes into their pension plan an amount of £50,000. Under these circumstances the pension contribution does not exceed the annual allowance which can be paid as contributions with no annual allowance charge.

The following example illustrates how the charge will operate...

A member earns a salary of £120,000 and makes a personal pension contribution of £100,000 gross. This is allowed for tax relief purposes due to the fact that the member has unused carry forward relief from the pension input periods ending in the 2008/9, 2009./10 and 2010/11 tax years of £50,000 to add to the 2011/12 Annual Allowance of £50,000. The employer recognises the essential nature of this employee and their huge contribution to the business and contributes into their pension plan an amount of £220,000. As the total pension contributions (£320,000) are in excess of the current available allowance of £100,000 there is an excess of £220,000.

Although the excess has been created by the employer’s contribution, the excess charge will be levied on the member at a rate of 40% to the extent that his taxable income does not exceed £150,000 and 50% on the balance of the excess contribution.

The above situation could also apply to a member of a defined benefits scheme who has, for example, been promoted and receives a retrospective increase in benefits. The resulting increase in value for the pension input period in question may mean the client exceeds the 2011/12 annual allowance and any available carry forward of unused annual allowance that could receive relief in the current tax year.

Generally, contributions paid by an employer for a general employee should be relevant for the position held within the company and broadly comparable with a similar role within the workplace. Typically this will take into consideration the whole remuneration package including bonus, salary and benefits including pension contributions. HMRC will use the 'wholly and exclusively' rules laid out in the Business Income Manual (BIM) which can be found on www.hmrc.gov.uk and specifically the rules laid out from section BIM46030 onwards. An example would be that it is unlikely that a pension contribution of £20,000 would be accepted under these rules for an employee earning £10,000 in a minor role for the company.

It can be more difficult for a controlling director to have the test above applied to them as in many circumstances they will take reduced salaries for the benefit of the company or take dividend payments. As a general rule of thumb it has been said that a director may take a remuneration package (including salary, bonus, benefits, pension contributions etc) which is justifiable based on the position held within the company and would be comparable to an arms length package paid to another individual holding a similar position. This should be acceptable as an allowable business expense. Again, further details are laid out in the BIM.

Please note that these are only broad descriptions and each case will be looked at on an individual basis by the Inspector of Taxes in line with their interpretation of the regulations.

Where the employer is a limited company they can normally treat any pension contribution as a business expense and offset it against corporation tax due, as long as the ‘wholly and exclusively’ rules are met in relation to the UK trade being carried out. Where the employer is a sole trader or partnership the contributions will be set against the income tax liability of the sole trader or partners within a partnership.

It should be noted that in both of these cases, if the employer contribution is not allowed to be offset as a business expense, it cannot be refunded. Although this may be refused as a business expense it is still an allowable pension contribution and as such there is no facility to refund such a contribution.

Spreading of tax relief on employer pension contributions means the tax relief granted against corporation tax is spread over a number of years rather than all given in the same trading year. Spreading of tax relief may occur when there is a substantial contribution made by the employer.

Spreading will generally occur in circumstances where the contribution level is in excess of £500,000. However, there are many other issues that will be taken into consideration at the same time before spreading is implemented.

These are covered in a four stage process of:

• Establishing the level of pension contributions in the current year and previous chargeable period (accounting period),
• Establishing whether there has been any change in these chargeable periods,
• Comparing the level of contributions,
• Seeing if there has been an excess and if so, is the excess over £500,000?

The legislation has been written in such a way that if no comparison can be made with the previous year’s chargeable period as nothing was paid (eg the first year of the pension scheme) the tax relief cannot be spread. This may be of benefit for controlling directors as they may be able to make ad-hoc contributions every other year and avoid tax relief spreading. This may be very beneficial with companies with vastly fluctuating profits where pension offsetting against corporation tax can be used for those years with high company profits.

When determining if spreading is necessary you will look to see if the contribution in the current year is more than 210% of the contribution made in the previous year. This increase in contribution excludes allowances for cost of living increases and for new members joining the scheme in the current year.

If this level is reached, the excess amount will be deemed to be anything over 110% of the contributions paid in the previous year. If this amount is more than £500,000, spreading will be applied. The spreading of tax on the excess will be treated as follows:

£500,000 – £1 million: tax relief spread over two years
£1 million – under £2 million: tax relief will be spread over three years
£2 million or more: tax relief will be spread over four years.

Employers need to be aware of the impact a large pension contribution may have on a member should the contribution take that member over the annual allowance or, if applicable, the annual allowance and any carry forward of unused annual allowance from the three preceding pension input periods.

The annual allowance is currently set at £50,000 (tax years 2011/12-2014/15). If this limit, together with any additional contributions in respect of any carry forward of unused relief from the previous three pension input periods, is breached any surplus contributions or value of benefit accrual for defined benefit schemes will mean the member will face a tax charge on the excess. The level of the tax charge will depend on the notional level of income tax the member would be liable to if the excess accrual was added to the total taxable income the client would otherwise be subject to. This tax charge is levied on the member irrespective of the source of the contribution.

It is worth noting that both these scenarios will involve legitimate employer pension contribution and these will not be refundable.

A-day legislation defined only two types of pension contributions – personal contributions (including third party contributions) and employer contributions. This means that it is possible for an employer to make a pension contribution for any person who used to be in their employment in exactly the same way they make contributions for their current staff.

As long as the employer pension contribution is ‘wholly and exclusively’ for the purposes of the business this can be used to create or extend a loss within the company’s accounts. Once this loss has been created the loss can be carried forward to be used against future year’s profits.

It must be remembered that the pension contribution will need to meet the correct criteria as explained previously to wholly offset against corporation tax and if HMRC does not agree with this it will mean that this will still create a loss (as this is still an expense of the business) but this loss can not be carried forward and offset against future company gains.

It is possible for an employer to pay pension contributions for overseas employees into a UK registered pension scheme. However, the requirements may be a little different for personal pensions and occupational pension schemes.

For occupational pension schemes generally the scheme is set up by application from the sponsoring employer which will generally have a UK registered office and so be UK based. The acceptance of employee membership does not actually set up a new scheme but is just a contract within the scheme whereby the employers agree to accept this employee as a member of the scheme.

Under this scenario we are talking of a wholly UK based pension scheme and so there are no concerns from HMRC about allowing this and the company should be able to offset pension contributions against corporation tax in the normal way.

However, there are certain EU directives that lay out the need for pension scheme trustees to abide by certain rules. These were introduced into the UK by legislation from effect from
30 December 2005 by Pensions Act 2004 and by SI 2005/3381.

Under s287 of the Act the trustees of an occupational pension scheme must not accept any contributions from a European employer* resident in an EEA state unless:

1. they are authorised by the Pensions Regulator
2. they are approved by the Pensions Regulator; and
3. either two months have elapsed since the date the Pensions Regulator notified the trustees that they are approved to receive contributions from the specified employer, or the trustees have received information from the Pensions Regulator passing on information received from the host member state.

The law described above applies to occupational pension schemes only and does not apply to personal pension schemes. However, personal pension schemes will also have their own constraints as to contributions although these will have less of an effect on the employer.

To take out a registered pension scheme and receive tax relief on personal contributions the client will need to normally be UK resident at the point of application. This is because the insurance company may not be licensed to sell products to those people resident in another country. Assuming these conditions apply then the employer can continue to make pension contributions for the employee and receive corporation tax relief.

*European employer also encompasses UK employers.