Exam Traps: Tax Stumbling Blocks – Employer pension contributions

Taxation is one of the most complex and important topics that underpins much of financial planning – and it’s the topic that causes most consternation for students.

Tax is tested across multiple papers of the diploma and advanced diploma modules. It can seem complicated, but mostly it is about following a process or set of rules. Once you know the rules, you should be well on your way to exam success.

Here we examine Employer Pension Contributions an area that typically cause confusion or trip up students.

Employer pension contributions

Employer pension contributions are typically classed as a business expense. They can then be used to reduce corporation tax for limited companies or income tax for sole traders or partnerships by way of tax relief.

HM Revenue & Customs says a large contribution must be spread over a number of periods if the following applies:

  • the contribution exceeds 210% of the contribution the employer made in the previous period (known as the chargeable period);
  • the amount by which the contribution exceeds 110% if the previous contribution is £500,000 or more. This is known as the excess.

The spreading is based on the excess. When this is between £500,000 and £999,999, the tax relief is spread over two accounting periods, so divide the excess by two. If between £1m and £1,999,999, the relief is spread over three periods, so divide the excess by three. If £2m or more, divide by four.

Here is an example to see whether spreading should occur. Company X made a pension contribution of £700,000 during the last period. This year it makes a £2,000,000 contribution. Firstly, does the new contribution exceed 210% of the previous contribution? Let’s see: 210% x £700,000 = £1,470,000. As the new contribution of £2,000,000 is greater than £1,470,000, the first point has been met.

Now for the second. Is the amount by which the new contribution exceeds 110% of the previous contribution £500,000 or more? Let’s see: £2,000,000 – (£700,000 x 110%) = £1,230,000. This is more than £500,000, so spreading needs to occur.

The excess amount of £1,230,000 falls between £1m and £1,999,999, so it is divided by three, and a payment of £410,000 is given in each of the next three periods. The first is given in the current period, along with 110% of the previous year’s contribution, so in this case £770,000. The total relief is £1,180,000 in the current period.

Tax is a subject tested across multiple papers of the diploma and advanced diploma modules and it’s a topic that causes most consternation for students. Need extra study support? Check out our range of CII courses: https://redmilladvance.com/courses/

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