Companies usually receive corporation tax (CT) relief for pension contributions they make for their directors. The trouble is, your company won’t have a CT liability this year so what happens to the tax relief?
Personal or company contributions
Whether you pay pension contributions personally or get your company to pay them, they qualify for tax relief. As a rule of thumb, it’s more tax efficient for your company to pay employer contributions. However, if your company doesn’t have enough profits to cover them, will it be more advantageous for you to pay them instead?
Corporation tax relief timing
Before considering the tax effects of pension contributions you need to be aware of the special rule which determines when a company is entitled to a tax deduction.
Trap. Where your company pays employer contributions it’s entitled to deduct the cost from its profits for corporation tax (CT) purposes. But unlike other expenses, the deduction for pension contributions is allowed for the accounting period in which the contributions are paid and not when the expense is accrued for accounting purposes.
Example. Acom Ltd’s policy is to pay a pension contribution for its directors equal to 20% of the company’s profit. For the year ended 31 December 2022 its draft accounts show profits of £150,000 (before pension contributions), and so it accrues a cost of £30,000 (£150,000 x 20%) to cover the contributions. This reduces its accounting profit to £120,000. However, because the contributions aren’t paid until after 31 December 2022, Acom’s taxable profit for that year is unaffected by the £30,000 pension contributions, i.e. Acom will be taxed on profits of £150,000 and not £120,000 shown by its accounts. If Acom pays the £30,000 contributions in May 2023 it can claim CT relief against its profits for the year ended 31 December 2023.
Trap. There’s another special rule which can further delay tax relief for employer contributions but this doesn’t apply unless the contributions are at least £500,000 in a year.
Losses
If after allocating pension contributions to the appropriate year for CT purposes they create or increase a loss, tax relief is not lost. The normal CT rules apply, which means that losses resulting from pension contributions can be carried back against your company’s CT bill for the previous year.
If you choose not to carry back the loss it’s automatically carried forward and used to reduce your company’s taxable profit in later years.
Tip. As long as your company has profits equal to or greater than the losses, in the previous year or future years, it remains advantageous for it to pay pension contributions rather than for you to personally pay them.
Limits
Remember that while there’s no specific limit on the pension contributions your company can pay for you, the normal pension annual allowance applies. If employer contributions plus any you pay personally exceed the annual allowance, you’ll be liable to a tax charge.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.