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Finance (No. 2) Bill 2015: pensions tax measures
Practical Law UK Legal Update 5-617-4671 (Approx. 8 pages)
Finance (No. 2) Bill 2015: pensions tax measures
| Published on 22 Jul 2015 • United Kingdom |
The first Finance Bill of the new Parliament, and explanatory notes on the Bill, were published on 15 July 2015.
Speedread
The legislation necessary to put in place the pensions-related measures outlined by the Chancellor in the July 2015 Budget has been published as part of the Finance (No. 2) Bill 2015. The key provisions are as follows:
- Reduced annual allowance. From the start of the 2016/17 tax year, the annual allowance will be tapered for high earners. The taper will apply to individuals who have an "adjusted income" (including the value of employer pension contributions) of more than £150,000. For these individuals, the annual allowance will be reduced by £1 for every £2 by which their adjusted income exceeds £150,000, up to a maximum reduction of £30,000. Individuals with a "threshold income" of less than £110,000 (excluding employer pension contributions) will not be caught by the taper.
- Aligning pension input periods with the tax year. Amendments to the Finance Act 2004 (FA 2004) will align an individual's pension input period (PIP) with the tax year from 2016/17. This change is intended to facilitate the annual allowance taper. All PIPs open on Budget day closed with immediate effect.
- Annual allowance transitional rules for 2015/16. Complex transitional provisions in the Bill will apply for the 2015/16 tax year to protect individuals who might otherwise be adversely affected by the changes to PIPs. In particular, the annual allowance will be doubled to £80,000 and the money purchase annual allowance doubled to £20,000, while the tax year will be split into two mini tax years, pre-dating and post-dating Budget day.
- Taxation of lump sum death benefits. The Bill will amend the FA 2004 by further limiting the cases where the 45% special lump-sum death benefits charge applies following a member's death. From 6 April 2016, certain lump-sum death benefits payable from a registered pension scheme or non-UK scheme on the death of a member over age 75 will be taxed at the marginal rate of income tax that applies to the recipient, rather than under the special lump-sum death benefits charge, where the benefits are paid to an individual who is the ultimate beneficiary. If the recipient is a trust or a company without a marginal tax rate then the special lump-sum death benefits change will still apply.
The Bill received its second reading in the House of Commons on 21 July 2015. The committee stage is due to start on 8 September 2015.
Background
Since 6 April 2006, tax legislation has provided for an annual allowance on total savings made by an individual in any registered pension schemes. Originally set at £215,000, the annual allowance rose to £255,000 for the 2010/11 tax year. From the start of the 2011/12 tax year, however, the annual allowance was reduced significantly as a means of restricting the availability of tax relief on pension saving. For the 2015/16 tax year, the annual allowance is set at £40,000.
Since 6 April 2015, an additional money purchase annual allowance has applied alongside the standard annual allowance. This is set at £10,000 and is triggered when an individual flexibly accesses defined contribution (DC) pension rights in one of the ways set out in section 227G of the Finance Act 2004 (FA 2004). If the money purchase annual allowance is triggered, the individual has an "alternative annual allowance" of £30,000 for the tax year in question that applies in relation to further defined benefit (DB) or cash balance accruals.
For an explanation of the basis on which the annual allowance and money purchase annual allowance currently operate, see Practice note, Pensions tax: overview: Annual allowance.
Finance (No. 2) Bill 2015: pensions tax measures
The Finance (No. 2) Bill 2015 was published on 15 July 2015, following the Chancellor's July 2015 Budget the previous week. The Bill received its first reading in the House of Commons on 14 July 2015. Second reading took place on 21 July 2015, following which the Bill was committed to a public bill committee. The committee proceedings are due to start on 8 September 2015 and must conclude by 20 October 2015 (see Legal update, Finance (No. 2) Bill 2015: second Commons reading).
This update summarises the pensions-related provisions in the Bill. For more information on the relevant announcements made at the July 2015 Budget, see Legal update, July 2015 Budget: key pensions announcements.
Tapered annual allowance for high earners
From the start of the 2016/17 tax year, the annual allowance will be tapered for high earners. The taper will be enacted in new section 228ZA of the FA 2004 (introduced by clause 23 and Parts 4 and 5 of Schedule 4 to the Bill). The main points about the draft legislation are summarised below.
Who will the taper apply to?
The taper will apply to a "high-income individual". This is defined to mean someone who meets both the following criteria in a tax year:
- They have "adjusted income" for the tax year that is more than £150,000.
- They have "threshold income" for the tax year that is more than £110,000.
The use of an "adjusted income" measure will prevent individuals avoiding the taper by sacrificing salary in return for higher employer pension contributions. Broadly speaking, an individual's "adjusted income" is defined to mean his total pre-tax income after deducting various reliefs in accordance with section 24 of the Income Taxes Act 2007, except that any deductions made in relation to pension contributions under sections 193 or 194 of the FA 2004 respectively must be added back. Additionally, the value of any employer pension contributions in the tax year (less the amount of any contributions made by the individual or on his behalf) must also be added back.
The value of employer contributions in respect of an arrangement will be the total pension input amount for the arrangement for a pension input period (PIP) ending in a tax year under section 229 of the FA 2004. In other words, it will reflect the standard method of calculating an individual's pension input amount for an arrangement (subject to the deduction of member contributions). For DC arrangements, this means the actual value of employer contributions paid in a PIP ending in a tax year. For DB arrangements, this means the increase in value of the member's pension and lump sum rights over a PIP ending in a tax year. An increase in value will arise if the closing capital value of the member's pension and lump sum rights exceeds the opening capital value. For both the opening and closing value, the capital value of the member's rights is calculated by applying a factor of 16 to the annual rate of pension.
Certain lump-sum death benefits are also excluded from the adjusted income definition, where the lump sum is taxable as income in the hands of the recipient from the 2016/17 tax year (see Taxation of lump-sum death benefits below).
The threshold income concept is designed to act as an income floor and mean individuals are not caught by the taper purely through having made high pension contributions when they would not otherwise qualify as high-income individuals. An individual's "threshold income" means his total pre-tax income less any relief at source under section 192 of the FA 2004, plus any employment income given up in exchange for pension provision under any "relevant salary sacrifice arrangements" or "relevant flexible remuneration arrangements". These are effectively any such arrangements entered into on or after 9 July 2015.
How will the taper work?
The taper will reduce a high-income individual's annual allowance by £1 for every £2 by which his adjusted income exceeds £150,000, up to a maximum reduction of £30,000. For example, a high-income individual with adjusted income of £180,000 will have an annual allowance of £15,000. An individual with adjusted income that exceeds £210,000 will have an annual allowance fixed at £10,000.
An individual affected by the taper will still be entitled to carry forward unused annual allowance for up to three previous tax years on the existing basis, although the amount carried forward will be limited to the unused tapered annual allowance.
If an individual has flexibly accessed his DC pension rights and therefore become subject to the money purchase annual allowance, the "alternative annual allowance" applying to non-money purchase pension saving will be reduced to the same extent that applies to the tapered annual allowance, subject to a maximum reduction of £30,000. Hence an individual with adjusted income of £210,000 or more who has flexibly accessed his DC pension rights will have zero alternative annual allowance available. However, he will retain a £10,000 money purchase annual allowance.
Anti-avoidance provisions
Specific provisions that will be introduced in section 228ZB of the FA 2004 are designed to combat avoidance activity. Broadly speaking, the taper will continue to apply if an individual has entered into any "arrangements" and the following conditions are met:
- The arrangements reduce his adjusted or threshold income in a tax year.
- The resulting reductions are redressed in another tax year.
- It is reasonable to assume the main purpose (or one of the main purposes) of the arrangements is to reduce or eliminate the extent to which the annual allowance is tapered.
For this purpose, section 228ZB will define an "arrangement" as "any agreement, understanding, scheme, transaction or series of transactions (whether or not legally enforceable)."
Aligning pension input periods with the tax year
To facilitate the introduction of the taper, the Bill provides for PIPs to be aligned with the tax year for the future. This reform has several elements:
- New section 238ZA of the FA 2004 will provide that a PIP which started before 9 July 2015, and was open on that date, is deemed to have closed on 8 July 2015. The next PIP under the arrangement runs from 9 July 2015 to 5 April 2016.
- New section 238ZB will provide that for a new PIP starting after 8 July 2015, the PIP ends on the first 5 April after the start date. Each future PIP will coincide with the tax year. When an individual draws their benefits, section 238ZB(5) provides (rather unclearly):
"Once the individual has become entitled to all the benefits which may be provided to the individual under the arrangement, the last pension input period in the case of the arrangement is that in which that was first so".
(Clause 23 and Part 1, Schedule 4.)
Transitional annual allowance rules for 2015/16: doubling the allowances
A consequence of the changes to PIPs referred to above is that many individuals will have PIPs ending in the 2015/16 tax year that they would in the normal course of events have expected to end in the 2016/17 tax year. Transitional relief will therefore apply for the 2015/16 tax year, as follows:
- Under new section 228C of the FA 2004, the 2015/16 tax year will be split into two mini tax years. The period from 6 April 2015 to 8 July 2015 will be referred to as the "pre-alignment tax year", while the period from 9 July 2015 to 5 April 2016 will be referred to as the "post-alignment tax year".
- All members of registered pension schemes will have an annual allowance of £80,000 for the pre-alignment tax year, plus any available annual allowance carried forward from the three previous tax years. The annual allowance for the post-alignment tax year will be nil, although an amount of up to £40,000 may be carried forward from the pre-alignment tax year. Any unused annual allowance available from the 2012/13, 2013/14 and 2014/15 tax years under the standard carry-forward rules may also be used.
- If flexible access took place in the pre-alignment tax year, the money purchase annual allowance for savings made during that period will be doubled to £20,000, and the "alternative annual allowance" set at £60,000. For the post-alignment tax year, the money purchase annual allowance will be the amount of the £20,000 that has not been used from the pre-alignment tax year, subject to a maximum of £10,000. The alternative annual allowance will be nil for the post-alignment tax year, but again any unused annual allowance from the pre-alignment tax year (up to a maximum of £30,000) and any unused annual allowance from the three previous tax years can be added to this. If flexible access occurs in the post-alignment tax year, the money purchase annual allowance for savings made during the post-alignment tax year will be £10,000 and the alternative annual allowance will be up to £30,000.
- Special rules in new section 237ZA will apply for calculating pension input amounts in PIPs ending in the transitional year under DB and cash balance arrangements.
- Any annual allowance charge that arises in the transitional year should be reported by scheme administrators to HMRC in the usual way as a single annual allowance charge for the combined period.
- There are no additional reporting obligations on scheme administrators arising from the transitional rules. Administrators will need to produce pension savings statements for the 2015/16 tax year as a whole by 6 October 2016 on the normal basis, regardless of which mini tax year the statements refer to.
(Clause 23 and Parts 2-3, Schedule 4.)
Taxation of lump-sum death benefits
The Bill will amend the FA 2004 by further limiting the cases where the special lump-sum death benefits charge (set at 45% in the 2015/16 tax year) applies following a member's death. From 6 April 2016, the position will be as follows:
- Certain lump-sum death benefits payable from a registered pension scheme or non-UK scheme on the death of a member over age 75 will be taxed at the marginal rate of income tax that applies to the recipient, rather than under the special lump-sum death benefits charge. This tax treatment applies to the following forms of lump sum, provided the benefits are paid to an individual who is the ultimate beneficiary:
- an annuity protection lump-sum death benefit or pension protection lump-sum death benefit paid in relation to a member who had reached the age of 75 at his death;
- a drawdown pension fund lump-sum death benefit, flexi-access drawdown fund lump-sum death benefit, defined benefits lump-sum death benefit or uncrystallised funds lump-sum death benefit paid in relation to a member who had reached the age of 75 at his death or paid in relation to a member who died before reaching the age of 75, but where the lump sum was not paid by the end of a period of two years running from the date the scheme administrator first knew of the death or could first reasonably have been expected to have known of it; and
- a drawdown pension fund lump-sum death benefit or flexi-access drawdown lump-sum death benefit paid on the death of a dependant, nominee or successor over the age of 75 or under that age but not paid within the two-year period referred to above.
(Clause 22.) - If the recipient of any of the lump-sum death benefits referred to above is a trust or a company without a marginal tax rate then the special lump-sum death benefits change will continue to apply in that case (clause 21).
For background about the changes to the tax treatment of death benefits that came into effect on 6 April 2015, see Practice note, DC pension flexibility: overview: Changes to tax treatment of death benefits.
Comment
The introduction of the tapered annual allowance harks back to the high income excess relief charge that was legislated for, but never introduced, by the Labour government in 2010. One of the key criticisms of those plans was the sheer complexity involved, and the taper threatens to be nearly as complex. At least the alignment of PIPs with the tax year is a sensible move, although the transitional provisions for 2015/16 are highly complex, with the legislative effect unclear in areas such as identifying the final PIP applying to a member who draws their benefits.
Once the taper is in place, DB schemes may want to consider whether to introduce a provision in their rules designed to avoid triggering an annual allowance charge in the first place. For standard-form wording (which has not been updated to reflect the taper), see Standard document, Pension scheme trust deed and rules: Schedule 5: paragraph 3.