Budget 2009 analysis: new income tax charge from 2011/2012 on high earners' employer-provided pension benefits

Practical Law UK Legal Update 2-385-8738 (Approx. 5 pages)

Budget 2009 analysis: new income tax charge from 2011/2012 on high earners' employer-provided pension benefits

by PLC Share Schemes & Incentives

A new charge for high earners on the benefit of employer pension contributions, from 6 April 2011

As reported previously, those earning more than £150,000 per tax year will:

Have their income tax relief on pension contributions tapered down to the basic rate (currently 20%) from 6 April 2011. Those earning at least £180,000 per tax year will only get relief at the basic rate. Given the new marginal rate of 50% for these taxpayers (and assuming the basic rate will be unchanged), they will suffer tax on their own pension contributions at 30% (50% - 20%), plus employee national insurance contributions (NICs) at the new 2011/2012 marginal rate of 1.5%.
Be subject to special tax charges from 22 April 2009, to block attempts to avoid the restriction of higher rate relief on pension contributions from 2011/2012 by adjusting current employment benefits and increasing pensions savings (by both employees and employers) within tax years 2009/2010 and 2010/2011.

For more details, see Legal update, Budget 2009: a changed tax environment for remuneration planning.

Analysis of the budget documents and HM Treasury's response to press enquiries suggest that the 2011/2012 changes are meant to go further than a restriction of higher rate income tax relief on employee pension contributions. It appears that there will be a new liability for employees earning more than £150,000 in a tax year to pay income tax on the benefit of employer pension contributions and commitments made within the year (under both defined contribution and defined benefit pension arrangements). Relief from corporation tax for employer contributions will continue to apply for affected employers.

The implications for NICs are very unclear. The government has published some reassurance about employer NICs liabilities (see Source), but it is not clear exactly what this means. It is also unclear whether corresponding new employee NICs liabilities are intended. The fact that the reassurance about NICs has been addressed specifically to employers but not employees may suggest that new employee NICs liabilities are likely.

Presumably, the new charge will be tapered in the same way as the restriction of higher rate relief. If so, it would appear that the rate of income tax on employer contributions for those earning at least £180,000 per tax year will be 30% (the new 50% rate less the basic rate of 20%) and progressively less for those earning more than £150,000 but less than £180,000. (Employee NICs may also apply at the new marginal rate of 1.5%.)

At present, there is generally no tax liability on employer pension contributions (at least to properly run registered pension schemes) unless the total increase in value of pension benefits exceeds the annual allowance (currently £245,000 and £255,000 in 2011/2012).

Consultation

The government intends to consult on the details of the 2011/2012 changes, but has not published consultation documents yet (see Source). The government has emphasised fair valuation of the annual increase in value of defined benefit pension entitlements as one aspect on which consultation is especially needed.

Comment

This will be a major change for some affected taxpayers. It seems that many of them may suffer a substantial new tax charge on previously untaxed benefits from 6 April 2011. For someone earning more than £180,000 per tax year and in receipt of employer-provided pension benefits worth £100,000 per tax year, the new liability seems likely to be £30,000 per tax year (or £31,500, if employee NICs liabilities arise).

No mention has been made of how the tax will be collected. It would be straightforward to collect the new tax charge under PAYE from employer contributions in some circumstances (eg, in the case of monthly or annual employer contributions to a defined contribution pension arrangement) but it is not clear whether and how PAYE could work for all pension arrangements, especially defined benefit schemes and any unfunded arrangements. On the other hand, if the new liabilities are collected under self-assessment, this could give rise to cash flow issues for taxpayers.

The government has stated that some consequential income tax changes will be addressed in the 2009 Pre-Budget Report (see Source) but hopefully more detail will be released before then.

Source

This proposal was not flagged up prominently in the budget materials and raises lots of questions which the budget materials do nothing to address.

There is an implicit statement of the proposal in paragraphs 5.92 to 5.95 of chapter 5 of the budget report itself (especially in part of the last sentence of paragraph 5.92, which we have italicised in the quotation below):

"5.92 The 2008 Pre-Budget Report announced that the Government would maintain the lifetime allowance at £1.8 million for five years up to and including 2015-16. To ensure fairness, affordability and sustainability of tax reliefs, Budget 2009 announces that, in addition, from April 2011, tax relief on pension contributions will be restricted for those with incomes of £150,000 and over. From that level of income, the value of pensions tax relief will be tapered down until it is 20 per cent for those on incomes over £180,000, making it worth the same for each pound of contribution to pension entitlement as for a basic rate income taxpayer. This restriction applies to all contributions, including employers’, [PLC's emphasis] but employers will continue to receive full relief on their contributions into employees’ pensions through corporation tax and NICs.

5.93 The Government will consult business, pension fund trustees, the insurance and pensions industries, and other stakeholders to ensure that defined benefit pension schemes are treated fairly in relation to defined contribution pension schemes and personal pensions. It will want to arrive at the most appropriate method of valuing pension benefits of those with over £150,000 in defined benefit pension schemes and of valuing the related employer contributions. The Government will use this consultation to engage with stakeholders to introduce the new system in a way that minimises administrative burdens.

5.94 Given the importance of consulting on this measure, introduction before 2011-12 would be inappropriate. This means that, in the absence of any further changes, it would be possible for individuals to take advantage of the pensions tax relief while it is still available to them at the higher rate by making substantial additional pension contributions prior to the restriction taking effect. The Government’s assessment is that unless it takes action significant revenues would be at risk over the two years before implementation. In anticipation of the change, the Government is therefore including legislation in this year’s Finance Bill to prevent forestalling in this way whilst permitting individuals to continue to receive tax relief at the higher rate on the higher of £20,000 or their normal pattern of contributions. This legislation will apply with effect from 22 April 2009. Those who have never earned in excess of £150,000 a year are unaffected, as are those who continue with their regular, at least quarterly, pattern of contributions or normal benefit accrual.

5.95 Following changes to the personal tax system, the Government will consider consequential changes to pension tax charges which are designed to recover the tax relief provided in certain circumstances. Pension tax charges apply, for example, when allowances are exceeded and in connection with unauthorised payments. The Government will provide details in the 2009 Pre-Budget Report."

Budget 2009 analysis: new income tax charge from 2011/2012 on high earners' employer-provided pension benefits | Practical Law