The intended use of the available funds should have a serious impact on the choices. To the extent that there is a desire to save the money available, then extraction directly from the company into a registered pension scheme will represent an extremely tax-effective choice.
Other factors must be taken into account in determining the appropriateness and attractiveness of a pension contribution compared with other uses for the funds but it is very tax-attractive within the allowable limits.
Assuming that the annual allowance is not exceeded and the contribution is made wholly and exclusively for the benefit of the company’s trade, the contribution will be a deductible expense.
It is worth remembering that tax relief for the company is available on unlimited contributions paid to a registered pension scheme provided they meet the general rules on deductibility – the wholly and exclusively test. HMRC has set out its views on the application of this test in its business income manual. Unsurprisingly, though, the wholly and exclusively test still gives rise to uncertainty in connection with substantial contributions made to schemes for controlling directors.
Despite the fact that employer contributions are deductible without limit, subject to the wholly and exclusively rule, this does not necessarily mean there is no other consequence to payments into registered pension schemes. If the total payments into a scheme by the employer and member exceed 225,000 in a scheme year ending in the current tax year, then there will be an annual allowance charge.
The rules surrounding this are quite complex but any annual allowance charge will be assessed on the member at 40 per cent on the excess over and above the annual allowance. So, if an employer contribution of 325,000 were paid and no member contribution were made, the member would have to find 40,000 even though the employer contribution may be wholly deductible, subject to satisfying the wholly and exclusively test and possible spreading of relief although the rules are quite generous on this. It is also necessary to take the lifetime allowance into account.
As to the timing of payment, for deductibility against a company’s profits for an accounting period, it is essential that the pension contribution is made before the end of the accounting period.
So pension planning to affect the tax payable on a company’s profits for an accounting period that has ended by December 31, 2006 or March 31, 2007 cannot now take place. This is not so in connection with the dividend/salary decision. Dividends are paid out of post-tax profits so determining a dividend in connection with profits of an accounting period ending on December 31, 2006 or March 31, 2007 is possible.
It is also possible to affect the company’s taxable profits for a past year with a bonus payment. This is because the remuneration for directors and other employees is generally deductible for the period of account to which it relates, subject to the overriding rule that the amount is commercially justifiable. However, where the remuneration is not paid within nine months from the end of the period, the tax deduction is only given in the later period when the amount is paid.
The date of payment for this purpose is the same as the date of receipt for income tax purposes, namely, the earlier of:
– Actual payment of earnings or on account of earnings or
– Entitlement to payment of earnings or to paymenton account of earnings.
In the case of a trading company, the remuneration or bonus should be deductible against profits. It is very rare for an inspector to challenge the level of remuneration paid to working director-shareholders. The amount paid to owner-managers will generally stand up to scrutiny as being a commercial rate, given their role in the company and responsibility involved.
A special rule applies to remuneration which is accrued or unpaid at the end of a company’s accounting period, such as provision for a bonus. Such remuneration can only be deducted against the company’s taxable profits for that period if it is paid within nine months after the period end.
As stated above, in the case of directors, the date of payment is often the time when payment is actually made or when the director becomes legally entitled to the amount although the statutory definition also includes other events.
Unless a director has a service agreement, his remuneration can only be determined when it is approved by shareholders at the company’s annual meeting, which is normally the date when the annual accounts are signed.
It is not too late to have the dividend/salary debate in connection with profits of a year that is within nine months of having ended, with accounts not yet submitted. This may be particularly appropriate in respect of companies with December 31, 2006 or March 31, 2007 year ends.
It will be too late for an employer pension contribution to affect those profits – there being no carryback provisions – but this should prompt an agreement to consider the relevance of contributions for the current year and planning in time to secure a deduction against profits.