Understanding Pension Contributions

Companies are constantly looking for ways in which they can lessen their tax burden. For public limited companies and incorporated associations, Corporation Tax can see as much as 21% of their profits paid straight back out again in tax (from April 1st 2015, this will be 20%), and so it is vital that organisations make as effective use as possible of the numerous forms of relief available.

One of the key ways in which organisations can cut their corporation tax liability is through claiming tax relief on any allowable payments that they have made during the course of the previous tax year. The list of those payments against which organisations that are liable for corporation tax can apply for a reduction of their tax bill is long and the rules can be complex, but one of the most frequently incurred expenses is pension contributions.

Approved and Unapproved

In the first instance, it is important to note that there are two distinct types of pension plan: approved and unapproved schemes. Essentially, approved schemes have been designed with the input of HM Revenue & Customs (HMRC), and therefore carry with them all of the benefits and drawbacks of the pensions tax schedule. Unapproved schemes have been designed without HMRC's input, and frequently do not benefit from some of the relief available to members of approved schemes. (For more information, read our article Understanding Tax Relief.)

An employer will generally only be able to make a claim for tax relief on pension contributions that have been made to an approved scheme. Many employers offer occupational pension schemes, and it is highly likely that the majority of your employees will wish to contribute to approved schemes anyway. The exception to this tends to be working directors or shareholding directors. Unlike employees, who suffer from an upper limit of tax relief available annually on pension contributions, employers can claim unlimited tax relief on contributions. This can have significant implications for tax planning, particularly in the case of working directors who have control over their own levels of pension contribution.

A-Day

On April 6 2006 (known as A-Day), the tax regime for pensions was completely overhauled. After this point, in order to qualify for tax relief, any pension contributions are now required to meet the conditions normally applied to any other business expenditure; that is, they must be incurred 'wholly and exclusively' for business purposes. This is the case for trading companies, while companies that engage in investment activities must be able to show that their pension contributions meet the criteria for management expenses. Thus, pension contributions can be seen simply as another business expenditure that must be accounted for when calculating your profits chargeable to corporation tax.

HMRC has also made guidance available concerning how the test of 'wholly and exclusively' applies specifically to pensions. They say that there must be a viable business reason if pensions paid to shareholding employees are higher than those paid to non-shareholding employees of a similar value to the company. Furthermore, if an employee seems to have a comparatively low salary but a high level of employer's pension contributions, it must be proved that this is not as a result of National Insurance liability planning.

The Next Step

Now that you have read through the advice above, you might want to put it into practice. Our Income Tax Calculator lets you enter your salary and get a clear breakdown of your income tax, National Insurance, and take-home pay for the 2025/26 tax year. See exactly where your money goes. Try it now →