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Accelerating tax deductions for pension contributions

20/04/2017

In view of proposed new rules you’re going to divert this year’s bonus into your pension fund. But with only a few days before your company’s financial year end how can you ensure tax relief against this year’s profits?

Bonus payments

Obtaining tax relief for year-end bonuses isn’t usually a problem. When the accounts for the year are in their final draft you decide, based on profit, how much bonus you and your fellow director shareholders can take, and as long as it’s paid within nine months of your company’s financial year end it will get a corporation tax (CT) deduction.

Example. Tom, Dick and Harry are the directors of Acom Ltd. Its draft accounts for the year ended 31 March 2014 show a profit of £250,000. The CT payable on this is £50,000 (£250,000 x 20%) – due on 1 January 2015. On 30 June 2014 the directors vote themselves bonuses totalling £100,000 which includes employers’ NI of £12,127. This amount is shown as an accrued expense in Acom’s 2014 accounts and as long as it’s paid no later than 31 December 2014 it will reduce the CT bill due in January by £20,000 (£100,000 x 20%).

Pension premium pros and cons

This year the directors of Acom are keen to divert the bonuses to their pension funds. Because all of them are in their early 50s and assuming the proposed changes to the pension rules go ahead in 2015, they’ll be allowed to draw as much of their funds as they want when they reach 55. Up to 25% of it can be taken tax free. If Acom pays the £100,000 split between Tom, Dick and Harry’s pension funds, the tax and NI position would be that the company avoids employers’ NI, meaning the directors will get more value into their pension compared with taking a cash bonus, but the CT bill for 1 January 2015 won’t be reduced.

Trap. Unlike bonuses, tax deductions for pension contributions aren’t allowed until the pension company receives the payment. So if pension contributions are made by Acom in, say, June 2014, i.e. in its accounting year to 31 March 2015, the CT payment that will be reduced as a result will be that payable on 1 January 2016.

Timing v saving

However, from Acom’s point of view the saving in employers’ NI of more than £12,000 achieved by diverting the bonus outweighs the one-year delay in obtaining the CT reduction of £20,000. However, it could get the best of both worlds. Tip. Acom could extend its financial year to cover the date on which the pension company received the £100,000 of contributions. HMRC and company law allow accounting periods to be extended by up to six months. The drawback is that an application to Companies House is needed and extending accounting periods by that much might mean a lot of extra work for its accounts department.

Planning for next year

If Tom, Dick and Harry want to divert next year’s bonus to their pensions they can take steps to ensure Acom receives CT relief at the earliest date. To do this they should have draft accounts drawn up within a couple of days of Acom’s financial year end, decide how much they want to be paid to their pensions and make sure it’s received by the pension company within seven days of the accounting year end. The key point is that accounting periods can be extended by up to seven days without the need for a formal extension of the financial year, meaning it’s less trouble all round.

Have draft accounts prepared within a couple of days of your company’s year end. Decide from these how much can be paid into your pension fund. As long as the pension company receives payment within seven days, you can informally extend your company’s accounting period so that the payment falls within it.