'Wholly & exclusively' rule is limited - HMRC
HM Revenue & Customs have finally published updated guidance on the position of tax relief relating to employer contributions into pensions, confirming the 'wholly & exclusively' rule will only be applied in limited circumstances.
In the original guidance published for A-Day in the Business Income Manual (BIM) HMRC stated contributions would only qualify for tax relief if they were “wholly and exclusively” for the purpose of business. However, the rules have been described as both vague and confusing for both cotractors, IFAs, the industry and even for local inspectors of taxes who have to make the final decision on whether contributions meet the new rules. As a result, some parts of the industry were reporting cases of local inspectors reverting back to the pre-A-Day maximum funding rules, which led HMRC to state in September it would publish updated guidance for their inspectors, who should in the meantime refer back to headquarters in Nottingham before challenging any contributions.
Examples of some of the more confusing parts of the original guidance include the need to know what “the taxpayer’s subjective intentions at the time of payment” are, and whether a benefit arising from a contribution is planned or merely a “consequential and incidental effect of the payment”.
But in the new guidance (BIM46001) HMRC confirms the payment of a pension contribution is part of the normal costs of employing staff and as a result the “wholly and exclusively” rules will generally only be considered in limited circumstances.
It says: “It [the contribution] will only be disallowable where there is an identifiable non-business purpose for the employer's decision to make the contribution to a registered scheme, or for the size of the contribution.”
The two main areas concentrated on by HMRC will be:
- If there is a non-trade purpose for the size of the contribution paid in respect of a controlling director or an employee who is a close friend or relative of the controlling director or proprietor of the business
- Where contributions are paid by a party other than the former employer after a trade has ceased or been sold, as such contributions are not allowed because they are not paid by the employer, although it points out they may be allowable as a deduction under general tax principles.
It adds: “There are limited circumstances in which a non-business purpose may exist for all or part of the contribution. You should remember that it is always a question of fact whether, in any case, there was a non-business purpose.”
As a result the new guidance, which is effective for all accounting periods ending on or after 6 April 2006, will particularly affect owners and directors of companies and any connected employees such as a spouse or child who may work for them.
In addition to help the local inspector of taxes to establish whether contributions are “wholly and exclusively” for business, HMRC says they should look for certain evidence, particularly in relation to related employees, such as whether unrelated employees are receiving comparable salaries and contributions which would suggest contributions are not for non-trade purposes.
This guidance allows contractors and advisers to plan pension contributions with more confidence, as it is clear the vast majority of pension contributions will receive full tax relief. It should now be acceptable for owners of companies to take a remuneration package up to the level of profits made by the company, as the profit usually reflects the value added by that individual.
For connected people such as spouses, pension contributions comparable with unconnected employees is acceptable, but if there is no comparable employee, a contributions which aims to provide a reasonable benefit at retirement - such as two-thirds of salary – shouldn’t give HMRC any cause for concern.
This is an area of some concern for contractors and they can only welcome the Revenue's intentions to give us clarity, and the guidance goes some way in doing that, giving practical examples of how the legislation and the principles involved can be interpreted.
With thanks to Julian Gilbert of Wealth MattersPensions, Business Tax, Expenses