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Thrown into relief

In recent weeks, I have been looking at the deeper tax implications of commission rebates, cashbacks and discounts.

As those of you who have been following this analysis will have discovered, the basic rules are not that difficult and are largely common sense. Ordinary retail customers are not usually assessable on any benefit they receive as a result of a commission rebate, cashback or discount. IFAs who are entitled to a certain level of commission but agree to receive a lower amount are assessed on the full amount of commission to which they are entitled less any amount used to benefit the client.

There are, however, some extra issues to consider, especially where the amount of a premium or contribution has other potential tax implications. The first of these to consider is where the policy which has given rise to the client benefit in the shape of a commission rebate, cashback or discount gives rise to a chargeable event, for example, on surrender, death giving rise to the payment of benefits under the contract or an excess over the 5 per cent annual allowance.

Chargeable event gains are computed substantially by reference to the premiums or lump sum paid. The amount treated as having been paid is as shown in the table below. Of course, the greater the sum treated as paid, the smaller will be the chargeable event gain.

So how about personal pension and retirement annuity contributions? Where contributions are paid by an individual, the amount of contribution eligible for income tax relief will be as follows, provided that the contract under which the commission arises is separate from the personal pension scheme contract. In this connection, it should be noted that the Inland Revenue does not state that it will not look at two contracts as being one. However, the Revenue does expect commission will arise under a separate contract.

(i) Where a gross contribution is paid and the policyholder receives commission, tax relief is given on the gross amount without taking the commission into account.

For example, an individual pays a gross contribution of £10,000 to his personal pension scheme. He receives a commission rebate of £400 from his IFA. For tax relief purposes, he will be entitled to tax relief on a contribution of £10,000.

(ii) Where commission is invested in the personal pension scheme, tax relief will be allowed on the increased investment as represented by the commission.

For example, an individual pays a contribution of £10,000 to a personal pension scheme. The commission to the IFA is £500. They agree that the IFA can take £200 and £300 will be added to the contract. The client will receive income tax relief for the additional £300 contribution.

(iii) Where, by agreement, commission is deducted from the contribution, relief is only allowed on the net amount paid.

For example, an individual wishes to pay a contribution of £10,000 to a personal pension scheme. Commission to the IFA is £500. They agree that the IFA should take £250 and the client pay a net contribution of £9,750. Income tax relief is given on £9,750.

The importance of the agreement for the commission payment being separate from the personal pension or retirement annuity contract cannot be overstated. If commission is paid to a client under the personal pension or retirement annuity contract, this would be an unapprovable benefit which would jeopardise approval of the contract. It should, however, be relatively easy to avoid this.

Commission may sometimes be payable in respect of a transfer of benefits between approved schemes. Reference is made in SP 4/97 to the potentially different tax treatment of commission if it is effectively not a benefit provided under the rules of the scheme.

More detail is contained in PSO Update 33, which deals with commission rebates that arise as a result of the direct or indirect movement from one investment vehicle to another. PSO Update 64 confirms that transactions such as annuity purchases are also within the ambit of PSO Update 33.

Next week, I will go on to look at examples of transactions which could compromise the tax approval of occupational and personal pension schemes.

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