For Use By Financial Advisors Only
This note is for general guidance only and is based on our understanding of the current position of the requirements for the treatment of pension contributions as an allowable expense. It does not guarantee in any way that adopting this will ensure that these will be allowable but endeavours to demonstrate that the requirements of HMRC are fulfilled thus making a very strong case for the employer. Specific advice should be sought in respect of each individual case.
Employer Contributions Background
Pre A Day, contributions by employers were treated as an allowable expense where these were certified as justifiable by the actuary for the funding of HM Revenue & Customs (HMRC) maximum benefits.
Since A Day, matters have changed considerably but the actuary’s certification still has value especially where an individual’s earnings are far lower than the intended employer contribution, thus potentially jeopardising tax relief for the employer.
Employer Contributions Summary
- Complications can arise where the employer wishes to make substantial contributions for directors or key employees whose relevant earnings do not support such contributions.
- Contributions made by employers, to be an allowable expense, must be incurred wholly and exclusively for the purpose of the employer’s trade.
- In order to put up a robust defence to any potential HMRC challenge, it is of great value to be able to demonstrate that a pension contribution made by the employer is pursuant to a contractual obligation.
- Many directors of small or owner managed businesses do not have formal service agreements in place.
- Agreements are straight-forward to implement, and their existence is a potentially invaluable aid to ensuring that the contribution is treated as an allowable expense.
Implementing the Service Contract
There are two elements to this:
- Service Contract – Pension Element 1 (BIM46020 – Appendix) Reward Structure Contributions made as part of a salary sacrifice arrangement can, in certain circumstances, be treated as allowable. Thus, whilst contracts can be open to challenge if they are not seen as an accurate reflection of underlying arrangements, the Service Contract should specifically state that such an arrangement would be acceptable as part of the terms of employment. In order to structure the risk and reward aspect of the director’s remuneration it is also essential that a significant proportion of the reward is directly linked to the performance of the director and the profitability of the business. Thus bonuses (especially if linked to objective factors) can play an important part in this arrangement.
- Service Contract – Pension Element 2 (BIM46025 – Appendix) Funding The second element is the funding of a pension arrangement to the maximum allowable without triggering any unauthorised payment tax charges. Employers have always regarded affordability as one of the important factors in the funding of pension schemes. This has in almost all cases been on an informal and ad hoc basis. This served good purpose as the actuaries report determined the allowable status of the contribution. Now, however, this needs to be formalised. Thus the Service Agreement should also specify that the employer undertakes to fund the director’s benefits to the Lifetime Allowance as long as it is affordable.
Where Trustees obtain actuarial advice on the funding and benefits of the Scheme on a regular basis, it ensures that if there are any contractual obligations on the part of the employer then these are evaluated and a planned funding strategy can be put in place.
In many cases this also meets the Trustees’ obligations as the Trust Deed & Rules of the Scheme may require them to obtain regular actuarial advice regarding scheme funding and benefits. Thus the contractual obligation can be complemented by an Actuarial Valuation Report.
The overall consideration has to be the value of the individual to the business. This is measured by the total reward for the individual including all benefits (pension contributions are an important part of this). Thus the reward of the individual must be broadly comparative to an equivalent officer in similar businesses generating broadly similar value.