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Wholly ghost

Meaningful guidance on the wholly and exclusively test is conspicuous by its absence

It seems that the nearer A-Day gets, the further away we get from understanding what the new rules mean in practice. The latest example of this phenomenon is the tax-deductibility of employer pension contributions, otherwise known as the wholly and exclusively test.

For some time, we have known about the potential problems that applying this test to pensions could cause. Since December 2002, to be precise. In the following three years, there have been many calls for the Revenue to set out exactly what the application of this test to employer contributions will mean.

When draft guidance was published two or three weeks ago, most of the blanks should have been filled in. Instead, the guidance, which will form part of the Business Incomes Manual (a tome that covers the taxation of businesses), merely restated many of the wholly and exclusively principles already in place.

The wholly and exclusively test already exists to stop businesses making tax-deductible payments that are not incurred for the purposes of the business’s trade. Paying excessive wages to the close relatives of directors, for example. Years of case law and Revenue practice dealing with the application of these rules have been amassed.

So what can we glean from these new draft clauses to be inserted in the Business Incomes Manual? First, that a contribution will only be disallowed where there is “an identifiable non-business purpose”. The guidance explains that a non-business purpose is only likely to exist where a contribution is paid in respect of the controlling director or an employee who is a close friend or relative of the controlling director or proprietor. Under these circumstances, the Revenue accepts that there is no non-business purpose if the contribution paid on behalf of the director or closely connected employee does not exceed the contribution paid for a “third-party employee”.

What we are not told is how friendly a close friend needs to be. I would guess that in many small businesses, the controlling director might get on very well with some of their employees. Does going down the pub together for a couple of pints every Friday evening constitute close friendship?

What if there is no “third-party employee”. What is then an acceptable level of contribution to pay on behalf of the director’s husband, wife, brother, daughter or drinking buddy? Is the business supposed to look to the wider world for a similar business that does happen to employ a “third-party employee” to be guided on a suitable amount?

What about the directors? Obviously, the concept of some third-party comparator cannot apply here so how much can the business pay on behalf of its directors? Does the profitability of the business have any bearing? What if the contribution creates a loss? What if the directors forgo salary in favour of pension contributions? Must this decision be documented? Lots of questions but few answers.

We need answers to these questions and similar ones. We need case studies, for example, showing employed spouses earning just under the primary National Insurance threshold. What are acceptable employer contributions in these cases?

Unless we have more certainty, advisers will find it difficult to give advice in these circumstances. A list of caveats as long as your arm will be needed to keep the FSA and Financial Ombudsman at bay when, inevitably, they display their uncanny gift of perfect hindsight.

It is understandable that the Revenue wants to retain a bit of leeway to use its discretion but these clauses provide no help at all. If they were goods for sale, they would fail the Trade Descriptions Act for claiming to be guidance.

So, dear Revenue, can we please have something that really helps us understand?


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