Employer contributions can enable large pension contributions to be made, including making use of carry forward where available.
Even though there are no limits imposed by HMRC on the maximum level of pension contributions an employer can make, contributions are likely to be limited by:
- The company’s Articles of Association.
- The pension scheme rules.
- The rules on tax relief on employer pension contributions. Tax-relievable contributions aren’t limited to 100% of the employee’s relevant UK earnings as they are for personal contributions, but they are usually granted under the ‘wholly and exclusively provisions’ requirement.
- The employee’s annual allowance. Contributions made to an employee’s pension count towards their annual allowance and, if the annual allowance is exceeded and any excess can’t be absorbed by using carry forward, the employee will be subject to an annual allowance charge. Where this is the case, any excess contribution is added to the employee’s income in the tax year of payment and taxed at whatever income tax rate the excess amount falls into.
If total contributions in a particular Pension Input Period exceed the annual allowance (plus any previous annual allowance available to carry forward) there will be an annual allowance charge on the employee up to 45%.
Effect on Corporation Tax
An employer is required to put the gross amount of a pension contribution through the company’s accounts as a business expense which will be deducted from profits before they are assessed for corporation tax.
The amount of tax relief available on the contributions depends on the size of the company’s profits and, hence, the rate of corporation tax payable. Tax relief on particularly large contributions may have to be spread over two to four trading years.
Granting of Tax Relief
The HMRC guidance makes it clear that pension contributions will normally pass the wholly and exclusively test and qualify for tax relief. But the granting of tax relief on an employer pension contribution is at the discretion of the company’s local Inspector of Taxes. Where there is a clear non-trade purpose, tax relief may be restricted or not allowed.
For it to be regarded as an allowable deduction against profits, a pension contribution must be made wholly and exclusively for the purposes of the business. This can be understood to mean that it is at a reasonable level for the employee/director concerned.
Pension contributions are likely to be allowed as a deductible expense if:
- the contribution has been funded under a valid salary or bonus sacrifice arrangement on the assumption that the remuneration sacrificed was an allowable deduction; or
- the contribution is contractual and uniform for all employees, eg, a matching 5% contribution to a stakeholder pension; or
- a defined benefit pension scheme is winding up and an employer contribution is made to meet its statutory funding obligations.
The pension contributions most likely to be challenged by HMRC are those made for a non-trade purpose. Candidates could be those made for controlling directors or more parties connected to them such as their relatives or close friends.
If the pension element of an individual’s overall remuneration package initially appears excessive, the Inspector of Taxes is likely to examine the individual’s overall remuneration package (salary, bonus, benefits and pension contributions, but not dividend income) and consider whether it is in proportion to the work they do.
If the Inspector of Taxes still thinks a company pension contribution was not made wholly and exclusively for business purposes, they will refer it to HMRC’s technical team who may limit the amount of tax relief.
An employer is allowed to make pension contributions for former employees, irrespective of when they ceased to be an employee. As with current employees, tax relief is at the discretion of the local Inspector of Taxes and contributions will be treated as a deductible business expense unless there is a clear non-trade purpose for them.