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How much can an employer pay into a pension?

The amount of contributions an employer can make to registered pension schemes for its employees is effectively unlimited.

But they don't always automatically qualify for tax relief - relief on any employer pension contributions is at the discretion of the local Inspector of Taxes. If the contributions are 'wholly and exclusively for the purposes of the business', tax relief will be given.

Employer pension contributions are paid gross and put through the business' account as an expense - part of the overall costs of employing staff - to be deducted from profits before they're assessed for either corporation tax (companies) or income tax (self-employed or partners).

On the flip side, there's also a minimum level of contributions that an employer must normally pay for certain employees under their workplace pension obligations.

The 'wholly and exclusively' test

Like any business expense, to be an allowable deduction against profits, pension contributions have to be made wholly and exclusively for the purposes of the business. Basically, this means that the contribution should be at a reasonable level for the individual concerned.

HMRC guidance makes it clear that pension contributions will normally pass the wholly and exclusively test and qualify for tax relief. But if there's a clear non-trade purpose, tax relief may be restricted or not allowed. This is unlikely when the employee is unconnected to the employer.

Pension contributions will always be allowed as a deductible expense if:

• funded under a valid salary or bonus exchange arrangement (on the assumption that the remuneration sacrificed was an allowable deduction) or
• the contribution is contractual and uniform for all employees - for example, a matching 5% contribution or
• a defined benefit pension scheme is winding up and an employer contribution is made to meet its statutory funding obligations

Pension contributions made wholly or exclusively for the purpose of a trade are generally treated as a deduction for corporation tax for the accounting period in which they are paid.

Where contributions result in a business loss, it may be possible to offset those losses against previous or future years profits where the employer had a contractual obligation to make those contributions. HMRC may restrict tax relief on contributions for a business owner (or connected parties) if these would otherwise create a loss.

If the amount of tax relief on employer contributions is limited, there's no option for the excess over the relievable amount to be returned to the employer. The whole contribution must remain in the pension scheme.

Investment companies can also make employer contributions for controlling directors or employees in the same way as trading companies can, but tax relief will typically be given as an 'expense of management', rather than under the 'wholly and exclusively' provisions applicable to trading companies.

Controlling directors

Controlling directors are able to decide how they're remunerated. So in these circumstances, the Inspector of Taxes will look at their overall remuneration package (salary, bonus, benefits and pension contributions - but not dividend income) and consider whether it's fair or excessive for the value of the work they do.

Where controlling directors are concerned, HMRC's guidance is generally positive stating that "it is unlikely that there will be a non-business purpose for the level of remuneration package".

If the individual's overall remuneration package initially appears excessive, the Inspector of Taxes may investigate the reasons for large pension contributions. There can be valid commercial grounds for making them - for example:

• a director might be nearing retirement with inadequate pension funds, having previously preferred to retain cash within the business
• a company may have had a good trading year or built up significant cash reserves, enabling it to make larger contributions than normal

If, after investigations they still believe the contribution wasn't made wholly and exclusively for business purposes, the amount of tax relief may be limited.

Connected parties

Pension contributions made for employees who are connected parties, such as the business owner's relatives or close friends, are those most likely to be challenged as being made for a non-trade purpose.

The Inspector of Taxes will look at the individual's remuneration package (salary, bonus, benefits and pension contributions) and consider whether it's excessive for the value of the work they do.

For example, if the remuneration package for a director's daughter is significantly more than that of an unconnected employee carrying out a similar role, this is an indicator that there may be a non-business purpose to the remuneration and relief may be denied.

Former employees

An employer can make pension contributions for former employees, irrespective of when they ceased to be an employee.

As with current employees, tax relief on these contributions is at the discretion of the local Inspector of Taxes. But, where an employer has committed to provide employees with a pension as part of their remuneration package, the costs of meeting that commitment will normally be a deductible business expense.

Relief may be limited, or not given at all, if there's a non-trade purpose for the contributions.

The employee's allowances

When looking at making employer pension contributions, there are some allowances which need to be borne in mind:

• annual allowance
• money purchase annual allowance

Exceeding any of these allowances can lead to tax charges for the employee.

Annual allowance

This is the total amount that can normally be paid, by an individual, their employer and any third party into their pension in a tax year without facing a tax charge.

The standard annual allowance is currently £60,000. But some high earners have a reduced allowance due to 'tapering' - possibly as low as £10,000.

If the annual allowance hasn't been used up in any of the previous three tax years, it may be possible to 'carry forward' the unused allowance. This can allow more to be paid in the current tax year.

Money purchase annual allowance

If an individual has taken more than just their tax free cash from their pension, they may* have a reduced annual allowance of £10,000 - this is known as the money purchase annual allowance (MPAA). If the MPAA applies, it also means that you cannot 'carry forward' unused allowances from earlier years.

But these two restrictions don't apply to the funding of defined benefit schemes.

* There are some exceptions that don't trigger the MPAA - for example, buying a guaranteed income for life (an annuity) or receiving a defined benefit pension.

Spreading tax relief

Employer contributions can normally only be treated as a deduction for the accounting period in which the contribution is paid - they can't be carried forward or back to a different chargeable period.

But when large employer contributions are made to a particular scheme, sometimes part of the tax relief due has to be spread over two or more years. Relief on employer contributions will be spread if:

• they exceed 210% of the contributions the employer made to the scheme in the previous chargeable period and
• the amount of the relevant excess is £500,000 or more

The relevant excess is any amount paid over and above 110% of the contributions in the previous chargeable period. If no payments were made in the previous chargeable period - for example, if a scheme has only just been established in the current period - then tax relief on any employer contributions in the current period won't be spread.

If there is a relevant excess, the number of years over which relief will be spread depends on the size of the relevant excess involved:

If an employer contributes to more than one scheme, the spreading rules are applied separately to each scheme.

Overseas employees

An employer can, in theory at least, make contributions to a UK registered pension scheme for an overseas employee and obtain UK tax relief. But there are issues which could rule these contributions out in practice:

• Personal pension schemes (PPS)
  If the employee has an existing PPS (including a SIPP, group PPS or stakeholder pension scheme) the employer can contribute to it. The five year restriction on tax relieved contributions that applies to an individual's contributions doesn't apply to employer contributions.
  
  But if an employer wants to contribute to a new PPS for an employee, the employer can't set the scheme up on their behalf - the employee has to do it themselves. And, for employees already based outside the UK, this may be difficult to do.
  
  The pension scheme provider needs the relevant regulatory approval to transact with individuals in the country in question. The individual's financial adviser may also need regulatory authority to give advice there.

• Occupational pension schemes
  Unless an employee is on a genuine secondment, the trustees or provider will have to satisfy themselves that they're meeting the regulatory requirements (if any) for the specific country if they allow contributions to be made for the non-UK resident member.

As a result of this, many providers or trustees won't accept pension business for non-UK residents.

In-specie contributions

Contributions to registered pension schemes must generally be in cash. The exception - where a contribution can be made by transferring legal ownership of an asset to a pension scheme, known as an in-specie contribution - is the transfer of ownership of 'eligible shares'.

'Eligible shares' are shares acquired through a savings related share option scheme (commonly known as SAYE, or sharesave, plans) or share incentive plan (SIP), where ownership is transferred to the pension scheme within 90 days of the individual becoming entitled to them.

Following a court case in May 2020, it is no longer possible to make in-specie contributions of non-share save scheme assets.

More information:

• HMRC's Business Income Manual - gives guidance on what a local Inspector of Taxes should consider when deciding whether to allow pension contributions as a deductible business expense.
• Annual allowance and the money purchase annual allowance
• Auto-enrolment - qualifying schemes and contribution levels