Trading businesses get tax relief on expenses that meet the ‘wholly and exclusively for a business purpose’ test.
A summary of the key considerations from HM Revenue & Customs’ (HMRC) Business Income Manual follows. However, advisers should check with their clients’ accountants on the appropriate level of pension contributions.
Most employer pension contributions fall into the ‘wholly and exclusively’ category on the grounds of being part of the cost of employing staff.
Key points about employer pension contributions:
- Not taxable on the pension scheme member
- Not restricted by the member’s relevant UK earnings in the tax year
- Count towards the member’s annual allowance
- Usually deductible expenses for the business when calculating its taxable profits.
HMRC could question whether there’s a non-trade purpose to pension contributions if a director or employee is connected to the business owner.
For example, it could deny tax relief on unusually high employer contributions for a business owner’s spouse holding the office of director while acting as a part-time administrator. In this situation, it expects the overall remuneration package to be in line with the market rate for an unconnected person doing the same role.
However, it’s different for a controlling director who’s the driving force behind their company. In this situation, HMRC accepts their overall remuneration – including the level of employer pension contributions – is a commercial decision. So it’s unlikely that HMRC will conclude there’s a non-trade purpose behind any level of pension contributions.
Consequently, shareholding directors of limited companies may have a pension funding option that isn’t available to self-employed people and won’t be offered to most employees.
Directors who receive only dividends or a small salary can benefit from significant employer pension contributions, as these aren’t limited by their relevant UK earnings in the tax year.
Of course, their total pension contributions should be within their available annual allowance to prevent a tax charge. And the lifetime allowance can be a consideration if their fund is approaching the current limit.
Timing of tax relief
Tax relief is given in the company or business year in which the employer pays the pension contribution.
It’s not usually possible to pay a contribution in one year and have it deducted in a different year’s accounts.
However, if the pension contribution generates or enhances a loss, this can be carried forward and offset against a later year’s profits.
Bernadette Lewis is financial planning manager at Scottish Widows