As an employer, you're required to pay pension contributions for eligible employees under auto-enrolment.1
One of the benefits of making contributions is that they can be used to reduce your corporation tax bill. So, you could decide to go a step further than your legal obligations by paying more than the auto-enrolment minimums, or by making employer contributions for all your employees.
In this article, we explain how this tax relief works – and help you identify if you’re eligible by answering some commonly asked questions. We’ll also explain how salary sacrifice can enhance the tax benefits for you and your employees. This information is based on our understanding of current taxation law and HMRC practice, which may change. The value of any tax relief will depend on individual circumstances.
What are the basics of understanding tax relief on employer contributions?
As an employer, you’ll pay contributions to your pension provider as gross amounts, regardless of the type of UK registered pension scheme in place. As long as these contributions are deemed ‘wholly and exclusively for the purpose of trade’ – meaning the payments are specifically for business purposes only – you can offset them against taxable profits to reduce your corporation tax bill.
Corporation tax is paid on your annual profits – and employer pension contributions can be deducted from profits before corporation tax is calculated. For example, if taxable profits in a tax year are £50,000, and £10,000 is paid in employer pension contributions, this means that corporation tax will only be calculated on £40,000. This is ignoring any other deductions that may be available.
The main rate of corporation tax that currently applies is 19%.2 Changes are planned for the financial year beginning 1 April 2023 that will introduce an increase to 25% for businesses with profits of £250,000 or above. If your business has profits of £50,000 or less, you’ll continue to benefit from the 19% rate corporation tax, with marginal relief applying to businesses whose profits fall between £50,000 and £250,000.
You should know that a reduction of your corporation tax bill isn’t automatic – it’s given at the discretion of your company’s local Inspector of Taxes.
Will my company qualify for tax relief on pension contributions?
For a trade or profession, employer contributions are tax deductible if they’re incurred ‘wholly and exclusively for the purposes of the trade or profession’. For an investment company, employer contributions are deductible if they’re classed as an expense of management.
It’d be unlikely for your employer contributions paid into a pension scheme to not meet the ‘wholly and exclusively’ rule – but it’s always best to check. HMRC emphasise that as part of the cost of employing staff, pension contributions will be allowable. They also state that it’d be relatively rare to have to consider whether there’s a non-trade or non-business purpose for the employer's decision to make a pension contribution. It will always be a question of fact as to whether that’s the case or not.
Simply put, any pension contribution you make as an employer to a registered pension scheme – in respect of any director or employee – will receive corporation tax relief unless there’s a non-trade or non-business purpose for the payment.
You can find out more about employer pension contributions and corporation tax relief in HM Revenue & Customs’ Business Income Manual.
Could salary sacrifice benefit my business and my employees?
Offering your employees the option of using salary sacrifice with their workplace pension could be beneficial for them and provide savings for you as an employer.
By ‘sacrificing’ some gross salary in exchange for an enhanced employer pension contribution, employees save on their National Insurance Contributions (NIC). This saving can be used to increase take home pay and add to the amount going into pension savings, or both – with no additional costs to the employee and without negatively impacting their take-home pay.
In addition, as the salary that is sacrificed is paid as an employer contribution, you’ll see a reduced employer NIC bill, as employer pension contributions don’t attract NIC. You could choose to add some or all of this saving to the pension contribution as part of the salary sacrifice, but you don’t have to.
Your NIC savings are likely to be modest if only a few of your employees enter into a salary sacrifice arrangement. Choosing to redirect all or part of those savings to increase pension contributions for your employees may encourage employee participation with your pension scheme. This isn’t guaranteed, and we recommend consulting your scheme adviser to help decide the best course of action for your business.
Notably, increased employer contributions from a salary sacrifice arrangement are likely to be treated as ‘wholly and exclusively for the purposes of trade’. This means they are allowable as a deduction when calculating a company’s taxable profits – potentially reducing your corporation tax bill further.
Salary sacrifice can’t reduce an employee’s gross salary below the National Minimum Wage or the National Living Wage (whichever applies), so it’s not suitable for everyone. It may also impact the amount of money they can borrow for a mortgage, or their entitlement to State benefits, so it’s important you point out and talk through the benefits and consequences of salary sacrifice with your employees before they enter into an agreement.
To learn more about how salary sacrifice works, check out our article, Salary sacrifice for employers – what you need to know.
What else do I need to know?
Although there’s effectively no limit to how much in employer contributions you can make for an employee in a tax year, your contributions will count towards your employees’ annual allowance. Any personal contributions your employees make – plus any third-party contributions paid on their behalf to any registered pension scheme – will also be included in their annual allowance for the tax year.
Contributing to your employees’ pension pots will provide a boost to their retirement savings and future financial security. If you can benefit from tax relief and an increase in scheme engagement while doing so, then it’s helpful to both you and your employees.