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The wholly truth

Without clarity on the meaning of ‘wholly and exclusively’, we must rely on sharing experiences.

How much an employer can pay into a pension plan and get tax relief has proved to be a thorn in the side of pension simplification. Cast your mind back to when A-Day was being devised. It was supposed to be very simple and prescribed, allowing no room for individual discretion.

People could get tax relief up to their earnings on their personal contribution. In addition, there would be an annual allowance – initially set at £215,000 – for both employer and employee contributions and any excess over this would be taxed at 40 per cent.

However, somewhere between the consultation papers and the final rules, we got another principle. This one said that employer contributions had to be “wholly and exclusively for the purposes of trade” – and if they were not, the tax inspector did not have to give full tax relief.

So, we came from a pre-A-Day world of strict rules and using maximum funding tests to calculate employer contributions to one where it seemed quite difficult to pin down what wholly and exclusively meant.

We have been waiting for final guidance to clarify the situation and the Revenue has issued this within its business income manual – updating the draft guidance it published over 12 months ago. However, at first sight, it is not entirely clear if it has moved the debate on.

It has certainly failed to give us a clear definition but it has expanded on the subject, giving a little more insight into where the Revenue’s thinking lies.

The first positive statement is that “the payment of a pension contribution is part of the normal costs of employing staff”. And that it will only be “disallowable where there is an identifiable non-business purpose for the employer’s decision to make the contribution or the size of the contribution”.

The Revenue then goes on to outline where its main concerns lie. These are, first, where there is a non-trade purpose for the size of the contribution paid for a controlling director or an employee who is a close friend or relative of the controlling director or business owner. Second, where the contributions are paid by a party other than the former employer after a trade has ceased or been sold.

It is the first one of these which will cause more uncertainty for advisers and, in deciding whether the contribution is allowable, the reason for the contribution needs to be examined. The general rule is that this involves looking at the employer’s “subjective intentions at the time of the payment”. But, unfortunately, this statement could be open to different interpretations.

There seems to be much more definition around what is allowable for pension contributions paid on behalf of employees who are relatives or close friends of the business owner or controlling director. In these cases, the Revenue is looking for evidence that they are in line with pension contributions paid to any comparable third-party employee.

This may be anyone who works alongside the husband or wife or friend and has a comparable remuneration package. It will also consider, if the pension contribution paid is much greater than that for a third-party employee, whether there is any business reason or any other special reason for the payment, for example, the pension fund may have a funding deficit at the time.

But in a lot of cases that advisers have to deal with, there are just two people employed by the business – the owner and their husband or wife. Finding a comparable third-party employee simply will not be an option. Instead, the contribution should be judged to give a reasonable salary replacement ratio.

This new guidance is to be welcomed but it does not give us all the answers. And it seems this is it. We will not get much more clarity from the Revenue. Instead, our understanding will come from practice and sharing experiences and the next few months will hopefully prove insightful.

The wholly and exclusively rule may be confusing but general principles apply. And as long as the contribution can be judged reasonable in terms of the work undertaken by and salary paid to the relative and the overall profit of the company, it should receive tax relief.

Rachel Vahey is head of pensions development at Aegon Scottish Equitable.

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