With corporation tax rates due to rise, Kevin Read explains why OMBs may want to consider deferring directors’ pension contributions.
Tax-efficiency of company pension contributions
Employer pension contributions are very tax-efficient. They will become even more so from April 2023, when corporation tax (CT) is increasing for companies with profits exceeding £50,000. For stand-alone companies, the marginal CT rate on profits between £50,000 and £250,000 will rise to 26.5% from the current flat rate of 19%, while for profits above £250,000, it will become 25%.
The director of an OMB will typically draw only a personal allowance-level salary, which restricts their own personal tax-relievable contributions, due to the rules on net relevant earnings [FA 2004, s 189(2)]. Company contributions are not restricted in this way, but a director may suffer an annual allowance (AA) charge if contributions exceed their available pensions AA, which is normally £40,000.
Another advantage of company contributions is that they are free of National Insurance, unlike a salary payment that is then used to fund a pension contribution personally.
Example
Consider £1,000 of pre-tax profit. A corporate pension contribution of £1,000 has £190 CT relief, which will become £250 if paid on or after 1 April 2023 (assuming pre-tax profits above £261,000).
What is the effective tax rate when benefits are eventually taken (assuming current tax rates, that the director is a basic rate taxpayer in retirement, and nil pension fund growth)?
- 25% tax-free sum is £250
- 20% tax on £750 balance when drawn as income = £150 tax.
Thus, the effective tax rate on extraction from the fund is 15%, significantly less than the tax relief the company received.
Deferring pension contributions
Deductions are only allowed for CT purposes in the chargeable period in which the contributions are paid; having an accrued liability for the payment is not sufficient. OMBs should consider accruing director pension contributions in the years to 31 March 2022 and 2023, with a view to paying the accrued contributions in April 2023, when CT rates for profits above £50,000 will be higher.
The accounts will look normal for the two years, as the director’s remuneration package is consistent, but CT relief increases by at least 6% if paid on or after 1 April 2023. This is a saving of £2,400 pa on an accrued contribution of £40,000.
A director with a £40,000 AA can carry unused amounts forward for up to three years, so the deferred payment will not produce any AA charge for them if made on or after 1 April 2023. The downside is that the director will lose out on potential pension fund growth on the £40,000 contribution until it is paid.
Practical tip
Deferring paying pension contributions while retaining remuneration packages of directors will help companies that are cash-poor at present due to the pandemic.
Accounting issues
To accrue £40,000 annual contributions in the accounts, the company must follow the provisions of IFRS, FRS 102 or FRS 105, which all require that essentially the same conditions be met.
1. A legal or constructive obligation to make the contribution.
2. It must be probable that payment will be made (although timing can be variable).
3. It must be possible to measure the accrued amount reliably.
In an OMB, it is the first condition that could be troublesome. A specific clause in a contract of employment would suffice if it commits the company to paying a pre-agreed non-discretionary sum as a contribution, either as a fixed percentage of salary or a fixed amount.
However, most directors of family businesses do not have an employment contract. In these circumstances, a pre-year-end board minute should suffice, where the contribution is communicated to the director pre-year-end.
