Tony Granger points out the level of pension contributions a company can make, and the tax impact of making them.
Pensions are a hot topic, especially with compulsory workplace pension schemes and auto enrolment in place. Whilst employer contributions are not restricted, they must generally satisfy a 'wholly and exclusively' requirement to receive tax relief. Furthermore, there is a tax knock-on effect for employees where certain limitations and restrictions apply. Employer contributions count towards the ‘annual allowance’ of the employee, for example.
Employer contributions
The employer can pay any amount of pension contribution into a registered pension scheme for an employee. This is regardless of salary.
Tax deductions as an expense rely on the contribution being ‘wholly and exclusively’ for the purposes of the trade. Pension contributions are included in the profit and loss account of the employer, reducing profits. HMRC could disallow contributions if they are excessive or there is a non-business purpose; however, these cases are rare.
Contributions must actually have been paid and are generally only treated as a deduction in the accounting period when paid. An exception to this is where HMRC treat the contribution as excessive (compared to normal contributions), when HMRC may require spreading of the tax relief over different accounting periods.
Salary sacrifice arrangements
A salary sacrifice happens when an employee gives up the right to part of the cash remuneration due under their contract of employment. An employee may also sacrifice a one-off item such as a bonus.
This non-cash benefit can be an increased contribution by the employer to a pension scheme.
This is generally ‘wholly and exclusively’ for the purposes of the trade and allowable as a deduction in arriving at the employer’s taxable trade profits.
Contributions made for a spouse or family member
There may be no corporate tax relief to the employer, but individual tax reliefs may apply to the employee. The contributions will be taxed as a benefit-in-kind to the employee and National Insurance contributions would be payable.
Controlling directors
A controlling director can control the different aspects of his remuneration, for example, small salary, taking dividends and large pension contributions.
As long as the ‘wholly and exclusively’ test is passed, then the company will normally get tax relief.
The position of the employee
Whilst employer contributions are unlimited, there are limitations on what can be paid on behalf of the employee in terms of possible tax consequences. For example:
- There is no need to have salary at a relevant level to receive employer contributions.
- The employee can generally receive contributions up to the maximum standard annual allowance of £40,000 (subject to annual allowance restrictions and payments to other pension schemes).
- Pension contribution checks must be made against the annual allowance (normally £40,000 maximum) and lifetime allowance (£1.03 million from April 2018).
- If the annual allowance, (including any carry forward allowance) is exceeded, a separate annual allowance tax charge is payable.
- The annual allowance limits the total of all contributions, including personal, employer and third-party contributions. It also limits the benefits build up in defined benefit schemes (such as final salary schemes).
- The annual allowance can be expanded by ‘carry forward’, which broadly accumulates unused annual allowances from the past three years and is added to the current year’s annual allowance. You must have had a registered pension scheme during that period to carry forward.
- If the annual allowance is exceeded, the excess is added to the member’s income and taxed at his marginal rate.
- The annual allowance may be tapered downwards according to earnings and type of pension scheme. It could be as low as £4,000 for the money purchase annual allowance.
- Tapered annual allowance applies if adjusted income is more than £150,000 and threshold income is more than £110,000 – both apply to reduce the £40,000 standard annual allowance to a minimum of £10,000 annual allowance.
Practical Tips:
Consider whether you are receiving the right mix of salary, dividends and pension contributions allowable within the annual allowance.
For employer provided pension advice, up to £500 per employee can be deducted by the employer.
Make annual allowance checks; tapered annual allowance may affect higher earners, creating tax charges on any excess contributions.
