As many of you will have read recently, HM Revenue & Customs has updated its guidance in the business income manual on relief of employer pension contributions in respect of controlling directors and dependants or close relatives of directors.
For those of you who like official references, it is BIM 46035 that has been updated. This continues to confirm that an employer pension contribution in respect of any director or employee will be an allowable expense unless there is a non-trade purpose for the payment.
It continues to indicate that one circumstance where all or part of a pension contribution may not have been paid wholly and exclusively for the purposes of the trade is where the level of remuneration, including the pension contribution, is excessive for the value of the work undertaken by the individual for the employer.
It goes on to indicate: “On occasion, an employer may make an increased pension contribution on the basis that a scheme is underfunded. It is important when comparing contributions between periods to consider the full facts, including the history of remuneration and contributions, before challenging a deduction based solely on annual comparatives.
“It should be borne in mind that the significant increase in qualifying limits with effect from April 6, 2006 will in itself facilitate and encourage an increase in contributions over earlier periods.”
It is indicated that one way of checking whether the contributions are paid wholly and exclusively for the purposes of the trade is to check whether the overall remuneration package for the controlling director and/or the close friend or relative of the controlling director is comparable with an unconnected employee. Where there is no comparable employee, reference needs to be made to pages BIM47105 and 47106.
BIM 47105 refers to specific deductions in relation to payments to dependants and close relatives of a controlling director. This repeats the comments in BIM 46035 that it is the overall remuneration package, including the pension contribution, that should be assessed and needs to be reasonable if it is to be regarded as wholly and exclusively for the purposes of the trade.
Helpfully, BIM 47106 indicates that “controlling directors are often the driving force behind the company. Where the controlling director is also the person whose work generates the company’s income, then the level of the remuneration package is a commercial decision and it is unlikely that there will be a non-business purpose for the level of the remuneration package. It should be noted that remuneration does not include entitlement to dividends, etc, arising in the capacity of shareholder”.
This could be important, given the strong continuing financial reasons for taking a dividend instead of a salary to generate significant National Insurance savings and thus diminish the “loss to the authorities” suffered on withdrawing sums from an owner-managed business.
When considering what action should be taken regarding an excessive remuneration package for a director or an employee who is a close relative or friend of a controlling director, BIM 47106 indicates: “If the amounts involved and the facts established indicate that a remuneration package is demonstrably in excess of what is commercially reasonable, then there may be other avenues to consider in addition to the question of whether an element of the payment is other than wholly and exclusively for the purposes of the trade. In particular, it may also be appropriate to consider whether the settlements legislation might apply or if payment is in fact part of the controlling director’s remuneration or the proprietor’s drawings rather than the market rate remuneration of the relative/friend employee.”
If a payment or part of a payment to a relative or close friend of a director appears not to form part of their remuneration, to the extent to which it appears to exceed what is reasonably commercial, then HMRC argues that it may actually be part of the director’s own remuneration. Therefore, although the payment may be wholly and exclusively for the purposes of the trade, it will in the following circumstances be taxable on the director rather than the employee if:
– The spouse or close relative is simply acting as a conduit for the director, in which case it may be taxable as earnings of the director, or
– The payment is made to a relative or a member of the director’s family or household, in which case it may be taxable on the director under the benefits’ legislation.
The comments made by HMRC concerning the general relief on employer pension contributions in respect of a controlling director are to be welcomed.
However, advisers may still need to proceed with some caution in highcontribution cases or cases where there is insufficient current profit to support the contribution.
The reference to the consideration of the overall remuneration package, including the pension contribution, is especially welcome and appears to recognise that many owners will vary the constituents of the overall remuneration package from year to year between salary, bonus, dividends and pension contributions to suit the circumstances at the time.