Employer contributions: 'wholly and exclusively'

The dawn of ‘Pension Simplification’ on ‘A-Day’ (6 April 2006), included HMRC’s revised guidance surrounding employer contributions to registered pension schemes (including SIPPs and SSASs).

This guidance, however, was published in their Business Income Manual (BIM), as opposed to their Registered Pension Schemes Manual, (which has since been superseded by the Pensions Tax Manual).

HMRC stated that employer contributions would only qualify for corporation tax relief if they were “wholly and exclusively” for the purpose of business.

Vague and confusing for everyone

In comparison to the prescriptive rules surrounding maximum employer contributions that existed before A-Day, the new guidance was described as both vague and confusing for employers, advisers, providers and even local inspectors of taxes, who are ultimately responsible for making the final decision on whether the employer contributions represent an eligible business deduction for corporation tax purposes.

Examples of some of the more confusing parts of the original guidance included the need to know what “the taxpayer’s subjective intentions at the time of payment” were, and whether a benefit arising from a employer contribution is planned or merely a “consequential and incidental effect of the payment”.

Rumours even circulated of local inspectors reverting back to the pre A-Day maximum funding rules, which led HMRC to state in September 2014 that it would publish updated guidance.

Post-simplification

Certainly, in those early post-simplification days, I was working for a firm of Independent Financial Advisers and recall grappling with the phraseology of HMRC’s original guidance, in an attempt to convert it into a plain-English answer to a plain-English question often - and understandably - posed by our owner-manager clients; namely, “how much can I pay in this year?”

The vast majority of contributions paid into a SSAS are paid by an employer.  This can either be the sponsoring employer of the SSAS, or a participating employer, (which often occurs where there are a number of separate organisations associated via a holding company).

Employer contributions to a SIPP are also common, although the structure of a SIPP lends itself more readily to employee and/or third party contributions as well.

Relief at source

In contrast, although employee contributions are usually allowable under a SSAS trust deed and rules, they are only eligible for immediate tax relief where the SSAS is operated on a ‘relief at source’ basis, (as SIPPs are).

In reality, however, SSASs tend not to be set up on a relief at source basis, which means that any member making a personal contribution into the SSAS would have to apply for tax relief via self-assessment, rather than it being claimed from HMRC by the scheme administrator, and credited to the SSAS. 

For this reason, SSAS contributions are typically paid by the employer contributions paid on behalf of the employee/member, as part of the employee’s remuneration package.

A deductible business expense

Thirdly, employer contributions are always paid gross and the employer can treat the contribution as a deductible business expense against their corporation tax bill for a trading year, provided that the employer contribution is demonstrably in the SSAS bank account before the company year end.

A SSAS is therefore often a favoured registered pension scheme for a limited company, where most, if not all, of the employees are also directors of the company. 

How much to contribute?

Not only are the contributions helping to build up a fund for each member’s eventual retirement, but they offer an excellent way of helping to offset the company’s corporation tax bill. As many limited companies’ trading year ends on 31 March, now is the time of year when employers are deciding how much they can contribute to their SSAS from their trading year profits.

Prior to the updated HMRC guidance becoming available, and in the continued absence of a court case or First Tier Tribunal decision to provide advisers with clarity to help them answer their client’s contribution queries, a ‘proxy’ that was often used was to ensure that the employer contribution did not exceed the average profits that the individual employee, (for whom the contribution was intended), generated for the business.

The role of the 'sleeping director'

And in those heady days before 2011, when it was possible for an employer to contribute up to £255,000 gross per tax year into a SSAS or SIPP for an individual employee, advisers were encouraged to look out for evidence of possible abuse, whereby the maximum employer contribution was paid on behalf of a ‘sleeping director’ – often a spouse - who rarely frequented the office premises, and did little else but, say, organise the office Christmas party.

The (unwritten and untested) belief was that contributions of this magnitude, with no evidence of profit-matching in the organisation’s ‘bottom line’ to substantiate it, were unlikely to be allowed to offset the organisation’s corporation tax bill for that particular trading year.

So...has HMRC’s revised guidance from early 2015 made the position clearer?

In the updated guidance, HMRC confirms that the payment of a pension contribution is part of the normal costs of employing staff and, as a result, the 'wholly and exclusively' rules will generally only be considered in limited circumstances;

“[the contribution] will only be disallowable where there is an identifiable non-business purpose for the employer's decision to make the [employer] contribution to a registered [pension] scheme, or for the size of the contribution.”

Additionally, page 46035 of HMRC’s BIM states that a “…pension contribution by an employer to a registered pension scheme in respect of any director or employee will be an allowable expense unless there is a non-trade purpose for the payment.  In cases where the contribution is part of a remuneration package paid wholly and exclusively for the purposes of the trade, then the contribution is an allowable expense [for corporation tax purposes].”

Consequently, the new guidance, which is (retrospectively) effective for all accounting periods ending on or after A-Day, will particularly affect owners and directors of companies and any connected employees, such as a spouse or child who may work for them.

And this is particularly pertinent for employer contributions to a SSAS, which are often utilised by family-run businesses.

Planning with confidence

The revised guidance does allow employers and their advisers to plan pension contributions with more confidence, as it is clearer that the vast majority of employer contributions will receive full tax relief.

Owners of companies will have more confidence in taking a remuneration package (including pension contributions) up to the level of profits made by the company, where the profit reflects the value added by that individual.

An accurate reflection?

However, there is now an increased focus by HMRC’s local inspectors of taxes to consider whether – particularly in relation to connected spouse and child employees – their salaries and pension contributions, made on their behalf by the employer, are an accurate reflection of their personal contribution to the overall profits of the company.

Any evidence of abuse in this area could lead to the local inspector of taxes concluding that “there is a non-trade purpose for the size of the contribution paid”, which could result in the employer not being allowed to treat some or all of the contribution as a deductible business expense against their corporation tax bill.

That caveat aside, advisers can only welcome the Revenue's intentions to give clarity in what is meant by the phrase 'wholly and exclusively', and the updated guidance goes some way in doing that, by giving practical examples of how the legislation – and the principles underpinning it – can be interpreted more clearly.