Pension employer contributions
This briefing sets out the points to consider for employers making contributions to pensions, including factors related to tax relief.
- Tax relief on employer contributions is given by HMRC allowing those contributions to be deducted as an expense before calculating profits that are taxable, providing they are paid wholly and exclusively for the purposes of the employer’s trade, profession, or investment business.
- Tax relief could come under closer scrutiny for employer contributions made when a company stops trading or for controlling directors and their close friends or relatives.
- Tax relief is usually given in the trading year in which the contribution is paid. There are rules for spreading tax relief for up to four years when a large, non-regular, contribution is paid.
- Employer contributions count towards an individual’s overall pension provision. It is therefore possible that a tax charge could arise for an individual because of an employer contribution being paid – the annual allowance tax charge.
- Where a member has pension benefits that already exceed their lifetime allowance, additional employer contributions will not generate further tax-free pension benefits. Additional contributions would generate pension benefits fully taxable against the member.
- Tax relief
- A business ceasing to trade or is sold
- Contributions for controlling directors and/or their close friends or relatives
- Spreading of tax relief
- Example of spreading tax relief
Tax relief on employer contributions to a registered pension scheme is given by allowing contributions to be deducted as an expense when calculating the profits of a trade, profession, or investment business. This reduces the amount of an employer’s taxable profit.
In the case of a trade or profession, employer contributions will be deductible as an expense if they are incurred wholly and exclusively for the purposes of the employer’s trade or profession. Where the employer is a company with investment business the employer contributions will be deductible as an expense of management.
HMRC has issued a chapter of the Business Income Manual (BIM 46000) which clarifies the position on the availability of relief on employer contributions where an employer is trading. In relation to investment companies the position is set out in HMRC’s Company Taxation Manual CTM08340.
There are two areas where an employer pension contribution might come under scrutiny.
1. A business ceases to trade, or is being sold
Whether tax relief is given will depend upon whether the contribution was paid as part of a contractual obligation to provide pension benefits to their employees as part of their employment package. If this is the case, the contribution should be tax relievable.
A number of examples (including previous case law) are set out in HMRC’s business income manual BIM 46040.
2. Contributions for controlling directors and/or their close friends or relatives
Where the controlling director is also the person whose work generates the company’s income, then HMRC indicates that the level of the remuneration package is a commercial decision, and it is unlikely that there will be a non-business purpose for the level of the remuneration package. For other cases, a key factor to consider is whether the level of the remuneration package is excessive for the value of the work undertaken by that individual for the employer.
General guidance on deductions for remuneration paid to close relatives of directors can be found at BIM 47105 and BIM 47106.
Spreading of tax relief
This can occur for large non-regular contributions. Contributions will generally only be allowed for relief in the employer’s accounting period in which they are paid. An exception to this will apply where an employer has made a very large non- regular contribution to a scheme in an accounting period when tax relief will be spread over up to four accounting periods. It is important to note that where an employer operates more than one registered scheme, that for the purposes of spreading of relief, the contributions to each scheme are considered separately (i.e. it does not apply to the combined employer contributions to all schemes).
An employer contribution in a chargeable period will be spread for tax relief purposes over up to four accounting periods where:
- it is more than 210% of the contribution paid in the previous chargeable period; and
- the amount of the excess (i.e. employer contribution less 110% of that paid in the previous chargeable period) is £500,000 or more; and
- the reason for the increased contribution is not either to fund a cost of living increase for pensioner members, or to fund or to meet a future service liability for new entrants to a scheme.
Where a spread is to apply, the excess will be spread in accordance with the following table:
|£500,000 or more but less than £1,000,000
|Over 2 accounting periods
|£1,000,000 or more but less than £2,000,000
|Over 3 accounting periods
|£2,000,000 or more
|Over 4 accounting periods
Where no contribution was paid in the previous chargeable period (e.g. where an employer has only just set up a registered scheme), tax relief on contributions in the current chargeable period will not be spread.
Further details of the spreading of tax relief, including examples, are set out in HMRC’s guidance within PTM 043400.
The following example will help to demonstrate how spreading of relief works:
Example of spreading tax relief