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Ultimate sacrifice

How the reduction in higher-rate tax relief and the antiforestalling provision will impact on salary sacrifice

Steve Folkard:  Head of pensions and savings policy Axa Life
Steve Folkard: Head of pensions and savings policy Axa Life

This year’s Budget is already loaded with horrors for wealthier clients. Abolition of the personal allowance for those earning over £100,000 creates an effective tax rate of 60 per cent on some income for those close to the threshold. The reduction of higher-rate tax relief kicks in at £150,000, tapering down to 20 per cent relief for those on incomes of £180,000. Then there are the complex rules around what contributions will trigger an additional tax charge – the anti-forestalling provisions.

What is less clear is how the new rules impact on salary sacrifice arrangements. The answer, as is often the way with pension tax, depends on what you have done and when you have done it (or intend to do it).

First a recap. HMRC announced its intention to reduce higher-rate relief in April 2009. However, although the proposed changes take effect from April 2011, they relate to “relevant income” in excess of £150,000 for the tax year when contributions are made or for either of the two preceding years.

What is relevant income? This is the total gross income less certain allowable deductions such as gift aid. Normal deductions from this then include pension contributions of up to £20,000 but this is where it gets a bit more complex.

In calculating relevant income, any income from employment which has been foregone in respect of a salary sacrifice arrangement must be added back into relevant income if the sacrifice arrangement was entered into on or after April 22, 2009.

However, it is not all bad news. Since HMRC has designed the regulations to prevent abuse, it has also made some important allowances for sacrifice arrangements which were already in place prior to April 22, 2009. If an existing salary Employers must take care that a review does not take place without careful cons-ideration if it will affect a significant number of employees who are high earnerssacrifice arrangement was in place prior to April 22 but is reviewed annually, then any reduction in salary resulting from subsequent sacrifices based upon review will be disregarded for the purposes of calcul-ating whether relevant income is in excess of the £150,000 threshold.

This seems rather unfair as on the face of it a client will have entered into a historic sacrifice agreement in good faith, having given up salary unconditionally, and the fact that a scheme happens to incorporate a review could not have been intended to facilitate any circum-vention of the higher-rate threshold.

Nonetheless, employers need to take care that a review does not take place without careful consideration if it will adversely impact on a significant number of employees who are high earners.

Employers must take care that a review does not take place without careful consideration if it will affect a significant number of employees who are high earners

However, HMRC has recognised this issue and a concession offered to this circumstance is that, where a salary sacrifice arrangement includes a default position that the sacrifice continues at the same level for the following year if it is not reviewed, then the amount does not have to be added back to calculate relevant income.

This means that, for a high earner whose existing salary sacrifice arrangement takes them below the £150,000 threshold, this arrangement can continue to be effective, provided that the agreement is not reviewed and contributions from sacrifice remain the same as in the year prior to April 22, 2009.

One further issue which may arise concerns redundancy payments and their interaction with salary sacrifice.

The situation may arise where an employee is offered the option of fore-going a significant proportion of their redundancy payment in order for the employer to make a one-off lump-sum payment to pension.

If the agreement to sacrifice the redundancy payment was established prior to April 22, 2009, then the amount foregone does not need to be added in for the purposes of calculating relevant income. In addition, if your relevant income was below £150,000 for either or both of the preceding two tax years, the special annual allowance does not apply.

So, overall, you can see that where sacrifice arrangements do not offer the discretion to artificially reduce an individual’s income for the purposes of avoiding tapered tax relief the rules, although rather messy, do achieve a reasonably equitable compromise.

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