The next step

An example illustrating tax efficiency

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BIM47106 - Specific deductions: staffing costs

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BIM46035 - Specific deductions: pension schemes

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Topping up a director’s personal pension fund

Retirement planning

Our subscribers are a husband and wife team who provide consultancy services through a company in which they have equal roles and own 50% of its shares. They take a small salary each year plus further amounts as dividends. This still leaves around £30,000 per year of profits in the company. They want to use the accumulated profits to pay into their personal pension funds. The most tax- efficient way to do this is for their company to make employer pension contributions , but only if the company receives corporation tax (CT) relief for them (see The next step ).

CT relief

Like most costs a company incurs in carrying on its business, a director’s remuneration is tax deductible only where it is “wholly and exclusively” paid for the purpose of its trade. If there is a non-trade motive for pension contributions they will not qualify for a deduction.

Trap. If a shareholder is not a director or employee of a company, a contribution paid by it to their pension fund is not a CT-deductible expense. Instead it counts as a distribution and for CT purposes is treated in the same way as a dividend.

Fair level of remuneration

HMRC generally accepts that payment of a pension contribution , even a large one, by a company is a legitimate way of paying a director shareholder and so will qualify for a tax deduction from its profits. However, its internal guidance on the matter is confusing. Its Business Income Manual (see The next step ) suggests that there can be a non-business motive for paying a large pension contribution, or a relatively large one based on the company’s financial position, for a director shareholder. If that’s so, some or all of the contribution won’t be tax deductible because it fails the wholly and exclusively test (see The next step ).

Tip. Contrary to HMRC’s guidance referred to above, elsewhere in its Business Income Manual it says “Controlling directors are often the driving force behind the company. Where the controlling director is also the person whose work generates the company’s income, then the level of the remuneration package is a commercial decision and it is unlikely that there will be a non-business purpose for the level of the remuneration package.” (see The next step ). In other words, the level of remuneration (including company pension contributions) won’t usually fall foul of the wholly and exclusively rule and so is usually tax deductible.

Trap. If a company pays a large contribution for a director who is not “controlling director” HMRC might challenge a tax deduction for their remuneration if the payment looks excessive for the nature of the director’s job. HMRC will compare what a normal employee would be paid for doing the same work as the director shareholder.

Conclusion. Where your company is paying pension contributions for a director shareholder out of profits, HMRC has no reasonable grounds for refusing a CT deduction for them.

For an example illustrating tax efficiency and for links to HMRC’s guidance on company pension contributions, visit https://www.tips-and-advice.co.uk , Download Zone, year 22, issue 8.