UK: Tax Provisions And Pensions After A-Day

The pensions regime for the self employed has changed radically from 6 April 2006 (A-Day). This may have a major impact on the way firms make provisions for tax.

Since A-Day, individuals are able to obtain tax relief on contributions of up to £215,000 into a pension scheme in any one tax year (subject to having sufficient net relevant earnings available). In the year of retirement the limit of £215,000 will not apply and relief will be restricted only where there are insufficient net relevant earnings to cover the premium. A lifetime value rule overrides these limits.

All pension payments will now be paid net of basic rate tax so that a £100,000 contribution would cost the individual partner £78,000 and a further £18,000 tax relief can be obtained via a reduction in the individual’s personal tax payments. It is no longer possible to make pension payments gross.

Currently many firms operate a policy whereby a full tax provision is made using a straightforward tax calculation. Where individuals make personal pension contributions and provide evidence of the premium paid, a release is made from tax reserves to help finance the premium. This release may be in advance of when the tax relief would normally be given through a reduction in the tax liability payable.

If the normal policy adopted by most firms were to continue, a situation could arise where a large number of partners decide to make the maximum contribution into their pension schemes. This would result in tax relief on each £215,000 at 18% becoming due to the partners from within the firm’s tax reserves. This could have a significant cashflow effect since tax reserves form part of the overall cash resources of the firm for its day to day management.

Equally, existing policy may produce an inequitable position between a partner who makes no pension contribution and a partner who makes the maximum contribution. An individual making no pension contribution will be funding the firm for longer through his tax reserves compared to an individual who makes the maximum pension contribution and who would therefore have smaller tax reserves to assist with the funding of the firm.

Firms are recommended to reconsider their policy in relation to releasing tax reserves where pension contributions are made. An appropriate policy should continue to encourage partners to make maximum pension contributions, but should reflect both the cashflow requirements of the business and equity between partners.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.