All Things Business Article
As an Entrepreneur and wealth manager, it used to be simple when advising likeminded individuals to extract capital from the company. We would simply equalise income between working spouses, and maximise income tax allowances, minimising the tax drag by using a combination of salary and dividends and then look to maximise pension contributions. In the good old days, there were no limits, bar what a company could afford and you could even pay into your pension vast amounts at the same time as disposing of your business.
Today though, the pension world is so very different and we are coming across more and more directors that are unaware of what you can and cannot do and the detail below is designed to help give you a broad overview. We will look at what the limits are today and what is permissible so as to try and help you avoid some of the common pitfalls we are seeing on a daily basis relating to the amount you can or cannot contribute to a pension either personally or via your company.
Contributions can be made either personally, or from the company with the following limitations:
- Personal Contribution Limits – Under HMRC rules, you are able to make a personal contribution of up to 100% of your ‘pensionable earnings’ or £3,600, whichever is higher, capped at £40,000. Most Directors will pay themselves a small salary and higher dividends, so it can be difficult to make any large contributions to pensions personally, as dividends are not treated as ‘pensionable earnings’.
- Employer Contribution Limits – The amount of contributions an employer can make to registered pension schemes for its employees is effectively unlimited (as long as there is cash in the business to make the contributions), but they don’t automatically qualify for tax relief. The gross contribution paid is put through the company’s accounts as a business expense, as part of the overall costs of employing staff, to be deducted from profits, before they are assessed for corporation tax. In certain circumstances, tax relief on large pension contributions by employers may also be spread over two to four trading years.
That seems simple and on the face of it, it is, but things are not as simple as they seem because of three things being: –
- The Annual Allowance and carry forward;
- The Tapered annual allowance;
- The Wholly and Exclusively Test.
And this ignores the annual allowance of £1m, £1.25m, £1.5m or even £1.8m depending on many other factors.
Annual Allowance (AA) and Carry Forward
The AA applies to either of the above types of contributions to you personally, which is currently £40,000 in the 2017/18 tax year. However, you can also ‘carry forward’ any unused allowances from the previous three tax years (you have to deduct any pension contributions that have been made in each tax year). You use the current tax year’s AA first, then you go back to the tax year three years ago, and then once you have used that, you go to the next tax year and so on until there is no allowance remaining. Carry forward is only available if you have had a pension plan previously.
- Current tax year first:
o 2017/18 tax year = £40,000 allowance available
- Then availability from previous three years in the following order:
o 2014/15 tax year = £40,000 allowance available
o 2015/16 tax year = £40,000 allowance available
o 2016/17 tax year = £40,000 allowance available
Therefore, the total available AA in the 2017/18 tax year is up to £160,000. Once the AA has been utilised in full, you have to wait until the next tax year. Any contributions made in excess of the available AAs will be subject to a tax charge, which is your highest marginal rate of income tax and after accounting for the tapered annual allowance calculations as detailed below.
Tapered Annual Allowance
Depending on your remuneration, you must analyse the impact that the ‘Tapered Annual Allowance’ may have on you. The Tapered Annual Allowance was introduced on 6th April 2016 as a way of restricting pension contributions for higher earners.
The standard £40,000 AA will be reduced by £1 for every £2 of ‘adjusted income’ individuals have over £150,000 in a tax year until their AA drops to £10,000. Adjusted income means all income (salary and dividends) and employer pension contributions. That means someone with £150,001 of salary, other income, dividends and employer pension contributions will be restricted to what they can pay into pensions either personally or by their employer. However, if your ‘threshold income’ is under £110,000 for the tax year, the employer contributions are not added into the calculation and tapering of your AA does not apply. The definition of each of the above is as follows:
|Adjusted Income||Threshold Income|
· Total income before tax from all sources* (ignoring deductions for personal pension contributions)
· Any employer pension contributions made in that same tax year
· Total income before tax from all sources*.
· Any salary sacrifice pension contributions made after 8th July 2015.
· Individual personal pension contributions.
*Total income before tax from all sources includes earnings from all employment/self-employment, pension income, dividend income, rental income, income from a trust, and interest from savings.
In summary therefore, if your threshold income is below £110,000, the tapering of your annual allowance does not apply. You still have the full available carry forward of annual allowances at your disposal and a company pension contribution can be made and corporation tax relief will be given subject to satisfying the Wholly and Exclusively Test as detailed below.
The Wholly and Exclusively Test
As with any business expense, tax relief on any employer pension contributions is granted at the discretion of the company’s local Inspector of Taxes. HMRC’s Business Income Manual gives guidance on what a local Inspector of Taxes should consider when deciding whether to allow pension contributions as a deductible business expense. Like any business expense, to be an allowable deduction against profits, pension contributions have to be made wholly and exclusively for the purposes of the business. This means that the contribution should be at a reasonable level for the individual concerned.
The HMRC guidance makes it clear that pension contributions will normally pass the wholly and exclusively test and qualify for tax relief. But where there’s a clear non-trade purpose, tax relief may be restricted or not allowed. Pension contributions will always be allowed as a deductible expense if the contribution is contractual and uniform for all employees, for example, a matching 5% contribution to an automatic enrolment scheme.
We hope this gives a little bit of clarity to what has become a very complex area. If not then please contact us on 01604 621467 and we would be delighted to discuss this further with you.
CEO & Founder