Ritson Smith hot topic: Corporation tax deductions for pension contributions

 
The following article has been prepared by David Dowell, senior tax manager with Aberdeen-based accountancy practice Ritson Smith.

Revised guidance on the tax deductibility of employers’ pension contributions was issued by HMRC in April 2006 and affects accounting periods ending on or after 6 April 2006.

One feature of the changes relates to the spreading of deductions for large pension contributions.  Normally, corporate tax deductions are allowed for employer pension contributions in the period in which the contributions are paid – however, where large pension contributions (ie in excess of £500,000) are made, the tax deduction given for the contributions has to be spread.  In essence, spreading of contributions over a number of periods will be required where there is an increase of over 210% in the level of contribution from one period to the next.

An equally significant change relates to the principle of tax deductibility of pension contributions.  The new legislation makes clear HMRC’s previously held view that contributions must be wholly and exclusively for the purposes of the trade if they are to obtain a corporation tax deduction.

The original guidance on this adversely affected pension contributions made on behalf of controlling directors and shareholders, particularly where linked to salary sacrifice arrangements.  Where a controlling shareholder received a low salary but received a significant contribution towards his or her pension scheme from the company, HMRC deemed this open to challenge.  

The revised guidance now instructs Inspectors to consider whether the overall package, and not merely the amount of the pension contribution, was paid wholly and exclusively for the purposes of the trade.

However, HMRC’s test for establishing a business motive would require comparing the remuneration package of the owner-manager of an SME with that of a third party employee. The comment has been made that such comparison is nonsense as there will not be another employee who takes on the same responsibility as the owner-director.

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