PENSIONS - 23.11.2006

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Your 2005/6 tax bill

Balancing payment. You may already have made payments on account for 2005/6 in January and July of this year. However, there might still be an outstanding balance to pay for 2005/6 by January 31, 2007 plus, of course, a payment on account for the current tax year, 2006/7. How can paying a pension contribution now possibly reduce your final tax bill for last year ?

For example. Say, the total tax due for 2005/6 is £1,500 - income tax on the extra £6,000 (net) dividend which you took from your company in January 2006, pushing you into the 40% tax bracket. Payments on account have been made; £450 on both January 31 and July 31, 2006. This leaves a balancing payment due on January 31, 2007 of £600 (£1,500 - (2 x £450)).

Backdate the payment. A personal pension premium of £3,000 paid before January 2007, can be backdated as if paid in 2005/6. It grosses up to £5,000 (£3,000 x 100/60) for a 40% taxpayer. This means you are entitled to £2,000 worth of tax relief.

The Taxman adds £1,100 (22/40 x £2,000) of this to your pension pot in cash. The remaining £900 (18/40 x £2,000) can be used to reduce your tax bill. At this point you can claim to treat the payment as made in 2005/6.

This means the £900 relief can first be offset against the balancing payment due for 2005/6 of £600.

The excess is then used to obtain a refund of £300 from the tax payments made on account for 2005/6. Is it really that simple? Yes, but the Taxman does like to throw in a few extra rules.

Backdating contributions

Tax return filed. The tax saving that results from backdating is worked out by reference to the tax position of 2005/6. So the Taxman says that the claim will not be put into effect until the tax return for 2005/6 (the earlier year) is filed. So if your tax return has already been filed, e.g. by September 30, you can make a successful claim.

Timing. Both the payment of the pension and the claim to backdate it to 2005/6 have to be made by January 31, 2007. Unfortunately, this does not affect the payment on account for 2006/7.

Paperwork

The election itself. The election (which is made by your pension scheme administrator) can relate to the whole or part of a contribution.

Higher rate relief. Where higher rate relief is available on the contribution carried back, you have to make an additional claim to your tax office. To do this send in a copy of the Form PP43 (new) or Form PP120 or a letter. A letter would need to refer to the date of election, date of payment and the amount carried back.

Trap. Where payment elections are made close to the January 31, deadline it may well be that Form PP43 (new) is issued by the scheme administrator for completion after January 31. Even though the form is completed and dated after January 31 this will not itself invalidate the claim. (Working Together Bulletin Issue 9.)

Tip. The backdating provisions for pension payments are very useful where the earlier tax relief would be at a higher tax rate, e.g. at 40% in 2005/6 instead of 22% in 2006/7.