Employer contributions and tax relief
These FAQs are for financial advisers only. They mustn’t be distributed to, or relied on by, customers. They are based on our understanding of legislation at the date of publication.07 September 2021 Back to results
Employer contributions to any type of pension arrangement in a registered pension scheme are always paid gross. Corporation tax relief for employer contributions is not automatic. Instead, it is given at the discretion of the local Inspector of Taxes (that is, the employer’s local tax office). Tax relief is given by deducting the gross amount of the contributions from an employer’s taxable profits before corporation tax is calculated.
For a trade or profession, employer contributions are deductible if they are incurred wholly and exclusively for the purposes of the trade or profession. For an investment company, employer contributions are deductible if they are classed as an expense of management.
In general, the HMRC guidance suggests that checking whether a contribution meets the wholly and exclusively test or expenses of management test should only be necessary in limited circumstances. HMRC emphasise that as part of the cost of employing staff, pension contributions will be allowable. They also state that it will be relatively rare to have to consider whether there is a non-trade or non-business purpose for the employer's decision to make a pension contribution and confirm that it will always be a question of fact as to whether that is the case or not.
In other words, a pension contribution by an employer to a registered pension scheme in respect of any director or employee will receive corporation tax relief unless there is a non-trade or non-business purpose for the payment.
A practical way of determining whether there is a non-trade or non-business purpose or not is to look at levels of remuneration. If an employee’s remuneration package (including salary, benefits and pension contributions) is not excessive in relation to their job, then an employer contribution should be eligible for corporation tax relief.
Employer pension contributions don’t attract National Insurance contributions, unlike other elements of remuneration, such as salary, bonuses, commission and taxable benefits in kind. This makes employer pension contributions a particularly tax efficient component of an employee’s overall remuneration package.
It is important to note that when referring to contributions made by an ‘employer’ this can include contributions made by a former as well as a current employer. It can also include contributions made by an employer in its capacity as a ‘sponsoring employer’ of a multi-employer scheme.
If an individual isn’t an employee, or former employee, an employer contribution can’t be paid on their behalf (a non-employee shareholder could fall into this category). A company could make a ‘third-party’ contribution in respect of a non-employee but this would be treated for tax purposes as having been made by the individual. Consequently, the employer would not receive corporation tax relief on such a contribution.
If a controlling director is the driving force behind a company and is instrumental in generating its income, then the level of the remuneration package, including employer contributions, is a commercial decision and it is unlikely that there will be a non-business purpose for the level of package.
For a controlling director of an investment company the situation is slightly different. An investment company is a company that mainly obtains their income from investments (e.g. from property). An investment company can make employer contributions to a controlling director’s pension arrangement, but they would need to qualify as an expense of management to be able to be deducted from the taxable profits before corporation tax is calculated.
If an employee or director is a connected person, their remuneration package should be compared to unconnected employees performing a similar job. If comparable, any employer contribution should be accepted for corporation tax relief. If there are no comparable employees, the remuneration package should be commercial and in line with the job undertaken. HMRC explain what a connected person is here.
An increased employer contribution from a salary or bonus sacrifice arrangement will normally be treated as being wholly and exclusively for the purposes of trade and allowable as a deduction when calculating an employer’s taxable profits.
Employer pension contributions don’t attract National Insurance contributions (NIC), so exchanging salary for an employer pension contribution results in employer NIC savings.
Are previous contributions and salaries relevant?(Expand content) (Minimise content) (Content loading)
A local Inspector of Taxes can take into account previous levels of employer contributions and employee remuneration for comparison against the current remuneration and proposed contribution. They can also make allowances where:
- large employer contributions are being made by an employer in an underfunding situation.
- an employer is required to make a payment to a scheme following a contribution notice issued by the Pensions Regulator.
- increased contributions are being made on leaving or retirement.
- contributions are being made as part of the sale or purchase of a business.
- advantage is being taken of the annual allowance and carry forward rules.
- an employer contribution is made to the Pensions Protection Fund.
In general, if salaries are less than a commercial rate and pension contributions appear to be inflated, then local Inspectors can try to find out why this has occurred. If tax or national insurance planning (other than for salary or bonus sacrifice) was one of the purposes for the contribution then it is possible that the full contribution will not be allowable as a business expense.
Can tax relief be spread over a number of years?(Expand content) (Minimise content) (Content loading)
It may be necessary to spread tax relief on employer contributions over a number of years. This applies when there’s a large increase in the level of employer contributions from one chargeable period to the next. If there are no employer contributions in the previous chargeable period, tax relief on contributions in the current chargeable period will not be spread.
There is a four-step process that should be followed to establish whether tax relief needs to be spread. Full details can be found in HMRC’s Pensions Tax Manual(Opens new window).
Can a proposed contribution be ‘cleared’ by HMRC?(Expand content) (Minimise content) (Content loading)
If there is any doubt about whether a proposed employer contribution will get corporation tax relief, the employer could seek confirmation from their local Inspector that the contribution will be relievable. However, in practice, a local Inspector may not be willing to provide such confirmation particularly at busy times such as around the end of a tax year.
HMRC’s Pensions Tax Manual:
HMRC’s Business Income Manual where the employer carries on a trade or profession:
HMRC’s Corporation Tax Manual where the employer is a company with investment business:
HMRC’s guidance in the Pensions Tax Manual, the Business Income Manual and the Corporation Tax Manual provides some certainty over the issue of corporation tax relief for employers who want to legitimately use pension contributions as part of the reward package for their employees. In particular, the guidance relating to controlling directors and connected employees confirms the information to be taken into account when assessing whether a proposed contribution will qualify for corporation tax relief. Using the guidance along with assistance from the local Inspector of Taxes should ensure that any potential issues are resolved before an employer contribution is made.
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