Tax treatment of company pension contributions
We've discussed company and personal contributions to pension schemes in an earlier post and this time we're going to focus on the tax treatment of company pension contributions generally - although not pensions auto enrolment.
Overview
Just to clarify, when we mention company pension contributions, we are referring specifically to owner managed companies.
Company pension contributions are payments made by a business into its pension scheme. This could be a defined benefit scheme, where the retirement benefit is determined by salary history and duration of employment, or more likely in the case of an owner managed company a defined contribution scheme. In this type of scheme the funds are invested and the retirement benefit depends on the investment's performance.
Tax treatment of company pension contributions - company's perspective
A company pension contribution may normally be included as part of a director's remuneration package, but it could also be part of a package for senior employees too.
Where the benefit of a pension contribution is part of a negotiated and regularly paid remuneration or bonus package there is potentially less likelihood of a challenge by HMRC under the 'wholly and exclusively' rule. This point is perhaps less relevant where company pension contributions relate to a director who eithers own a controlling stake or significant minority shareholding in the company concerned.
There is no restriction on the tax relief available to the employer. The company pension contribution can be deducted from taxable profits as long as it forms part of a reasonable overall remuneration package.
However, we'd mention that tax relief for the employer is based on when the contributions are paid and not the period to which they relate, or are accrued for. In addition, a significant increase in pension contributions may need to be 'spread' over multiple years.
The taxes legislation indicates that no liability to Income Tax arises where an employee’s employer makes contributions under a registered pension scheme. For example a director's company makes a contribution to the director's personal pension scheme.
The company's contributions are Income Tax and NICs free; so there is no benefit charged to the director/employee. However, tax relief for the employer may be limited under the 'wholly and exclusively' rule referred to above.
However an important point to mention is that pension contributions made by your company for family members are taxable, unless they are employed by your company. Therefore if your company does make pension contributions for your spouse more family member you may need to demonstrate they are employed in the business in a role that justifies the pension contribution - for example they are also a director.
Summary
There's no doubt that pension contributions can be valuable method of profit extraction from your company, especially given the changes in the 2023 Budget. However, where your company is intending to make significant contributions the above points should always be borne in mind.
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