Employer contributions and tax relief
- Employer contributions are not restricted, however they must satisfy the 'wholly & exclusively' requirement to receive tax relief.
- Employer contributions count towards the annual allowance.
- There are a number of scenarios when additional implications need to be considered.
How much can an employer pay into a pension plan?
In theory, an employer can pay any amount of pension contribution to a registered pension scheme in respect of one of their employees or an ex-employee, regardless of their salary. The problem is that tax relief is not automatic and it is up to the employer’s local inspector of taxes whether or not the employer receives tax relief on the entire contribution. It is therefore not always possible to be sure in advance whether an employer contribution will receive tax relief or not.
For tax relief to be given on employer contributions, they need to be deducted as an expense in calculating the profits of a trade, profession or investment business. They should be included in the profit and loss account of the employer and will subsequently result in the amount of an employer’s profit being reduced. In the case of a trade or profession the employer contributions will be deductible as an expense provided that they are incurred wholly and exclusively for the purposes of the employer’s trade or profession.
HMRC’s view is that contributions to a registered pension scheme will normally be allowed and that it would be ‘relatively rare’ for a pension contribution not to be for the purpose of the employer’s trade. It will only be disallowable if there is an identifiable non-business purpose for the employer’s decision to make the pension contribution or for the size of the contribution. If the local inspector thinks that a contribution may not have been made wholly and exclusively for the purposes of the trade, he must report to a central Technical Team to ensure such cases are treated consistently.
For further information HMRC has issued guidance on tax relief on employer contributions.
It’s worth bearing in mind that employer contributions count towards the annual allowance. More details of this can be found in our annual allowance article.
And is it as simple as that?
Not quite. As you’d expect, there are a few scenarios when there may be some additional issues to consider with regards to employer contributions. Let’s have a look at these.
Controlling directors can control how much remuneration they take from the business and the proportion that is taken in the form of salary, bonus, dividends and pension contributions. In particular, a controlling director may decide to take a small salary and the bulk of their remuneration as dividends for tax and national insurance reasons. Does that mean they have restricted the scope for tax relievable employer contributions?
The short answer is no. As long as it can pass the ‘wholly and exclusively’ test, an employer contribution will benefit from corporate tax relief.
The first step for HMRC is to establish whether the level of the total remuneration package i.e. salary, bonuses, commission, benefits in kind and pension contributions is commercially reasonable for the work done. Where a controlling director is the driving force behind the company and whose work generates the company’s income (e.g. where the controlling director is the sole owner and employee), the level of the remuneration package is a commercial decision and is unlikely to fail the test. A large employer pension contribution (in comparison to salary) may therefore be able to be claimed as an expense of the company.
However, the employer's contribution is deducted from the employer’s trading profits for tax purposes and can normally only be applied to the period of account in which it is paid.
Where an employee is unconnected to the employer it is likely that the remuneration package will be at a commercially reasonable level. Where the employee is a non-controlling director or a friend or relative of a controlling director, HMRC may want to be satisfied that the package is not unreasonable. If the package is in line with that paid to unconnected employees, it will normally be accepted as reasonable but if precise comparisons are not possible, HMRC will carefully consider the facts to establish whether or not the package is commensurate with the work done. If it appears that the spouse or relative’s package is actually part of the controlling director’s own remuneration, the payment may be taxable as earnings of the director, despite being wholly and exclusively for the purposes of the trade.
It’s also possible that a large pension contribution is being made to make up for investment losses made by the pension scheme. Depending on the circumstances, this could be acceptable even although the total remuneration package otherwise would not appear to be in line with the employee’s worth to the company.
Ex-employees and non-employees
As we have seen, where an employer has committed to provide employees with a pension as part of their remuneration package, the costs of meeting the commitment are normally tax deductible as an expense of the trade.
This can apply even where the decision or need to make the pension contribution happens after:
• the employees retire or leave the employer’s service
• the employer ceases to trade
• the employer sells the business in which the employees work.
The crucial point is whether or not the employer has agreed to make pension contributions as part of the employment package.
Employers and third party contributions
An employer can only receive tax relief on a pension contribution if it’s made on behalf of an employee (or in some circumstances an ex-employee).
A contribution can be made by a company on behalf of someone other than an employee (say the spouse or child of a controlling director) but such a contribution would be regarded as a third party contribution. A third party contribution is treated as if it had been made by the individual who would benefit from the relevant tax relief, as set out in pension contributions - the basics - the employer wouldn't be able receive corporate tax relief.
However, if an employer makes contribution for an employee's spouse or family member, as part of their employee’s flexible remuneration package the Finance Act 2013 includes provisions to ensure that these contributions will be taxed as a benefit in kind to the employee. The contribution will also be added to earnings for National Insurance purposes.
One final point worth bearing in mind....
Remember, tax relief can only be given on contributions that have actually been paid which can be substantially different from an amount in the profit and loss account showing an obligation in respect of defined benefit schemes. It is only the amount actually paid that can be considered for tax relief.
A contribution can also normally only be treated as a deduction for the accounting period in which the contribution is paid. It can’t be carried forward or back to a different charging period. An exception to this is when a much larger than normal employer contribution is made. Depending on the size of the contribution and how it compares with the employer’s usual level of contribution, HMRC may require the tax relief to be spread over more than one period of account. For more details on tax relief and spreading, please see the Registered Pension Schemes Manual: Spreading of relief.
All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.
In addition, the information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice.
Published 31 July 2008
Updated 19 August 2013
For professional advisers only