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Rules surrounding employer contributions

Date: 05 October 2021

Who is this article for?

Advisers wishing to understand the rules surrounding employer pension contributions and amounts that can be paid.

Key takeaways

What is the maximum payment that an employer can pay for an employee?

There is no defined maximum contribution an employer can pay with UK legislation. However, the employer may need to consider more than just the ability to fund unlimited amounts.

Any contribution made over the members available annual allowance will create an annual allowance charge which will subject the member to a tax charge. This charge will be levied on the member at the highest rate(s) of income tax the member pays. This can cause potential issues for the member as the contribution that has been paid is a legitimate contribution and cannot be refunded, so the member will have to find the money for the charge. Legislation is in force to allow, in many circumstances, for the pension scheme to pay any tax liability on behalf of the member through a process called scheme pays. This is available to both personal and employer contributions.

For corporation tax purposes the employer may wish to ensure the contribution is ‘wholly and exclusively’ for the purposes of the business (i.e., relevant to the position held within the company).

Further details relating to scheme pays

Who can the contribution be made for?

To be classed as a company contribution the member would need to be employed – or have been employed - by the company in the past. The standard definition of employer and employee is legislated for in Income Tax (Earning and Pensions) Act 2003. Under the pension legislation within the Finance Act 2004 (section 279), these definitions were extended to include former employees and former employers. An employee would broadly be defined as having some form of contract of employment. A business owner would be unlikely to have an employment contract with themselves, however, the same rules for funding levels would apply.

What is a ‘reasonable’ amount to pay for an employer or a director?

Generally, contributions paid by an employer for an employee should be relevant for the position held within the company and broadly comparable with a similar role within the workplace. Typically, this will take into consideration the complete remuneration package including bonus, salary, P11D’s and pension contributions. HMRC will use the 'wholly and exclusively' rules laid out in the Business Income Manual (BIM). An example would be that it is unlikely that a pension contribution of £50,000 would be accepted under these rules for an employee earning £10,000 in a minor role for the company.

It can be more difficult for a controlling director/owner to have the test above applied to them as, in many circumstances, they will take reduced salaries to reinvest into the company or take dividend payments. A common view is that if the total remuneration package would reflect what a similar company would pay a totally unrelated employee to cover the same position, this should be acceptable. Again, further details are laid out in the BIM.

Please note that these are only broad guidelines, and each case will be looked at on an individual basis by the Inspector of Taxes in line with their interpretation of the regulations. The corporate accountant should be in a position to have a view on the level of contributions HMRC are likely to allow due to their experience with the company accounts.

What tax relief is available on employer contributions?

Where the employer is a limited company, the contribution (if acceptable by HMRC) can be offset against the company’s corporation tax liability.

Where the employer is a sole trader or partnership the contributions will be set against the income tax liability of the sole trader/partners within a partnership. Remember, a sole trader/partnership can make contributions for the individuals they employer but not for the partners themselves. As they are the self-employed owners of the business any contributions for themselves will be a personal contribution.

As mentioned above under pensions rules, an employer’s level of contribution is unlimited. Therefore, if the employer contribution is not allowed to be offset as a business expense, it cannot be refunded as there is no legislative rule to refund such a contribution.

Summary

  • Employers can make contributions for current and historic employees.
  • Employer contributions are not restricted to 100% of relevant UK earnings – this rule is for personal contributions.
  • Employer contributions can be used to fund carry forward of unused annual allowance.
  • However, these contributions will count towards the member’s total annual allowance
  • The company may wish to restrict to level of contributions to a level they will gain corporation tax relief. The corporate accountants should be able to help guide the employee.

The information provided in this article is not intended to offer advice.

It is based on Quilter's interpretation of the relevant law and is correct at the date shown. While we believe this interpretation to be correct, we cannot guarantee it. Quilter cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.