RPSM09104740 - Technical Pages: Member benefits: Lump sums: Short service refund lump sum: Interest on payment

Interest paid on the short service refund lump sum

The definition of a short service refund lump sum includes an upper limit equal to the amount of actual contributions made by the member to the scheme. But the scheme rules may provide for the refund to consist of other monies on top of the actual contributions being refunded. The scheme administrator must determine the nature of the payment according to the scheme rules. The interest may be paid as a separately calculated amount or may form part of the lump sum payment.

Interest as a separately calculated amount

A registered pension scheme’s rules may provide for interest to be paid in addition to the contributions being refunded. The interest may arise simply because of a delay in making a payment or may be a payment over and above the computed lump sum for some other reason. If it qualifies to be treated as a scheme administration member payment (see below) for tax purposes, a payment of interest on top of the refunded contributions is an authorised payment.

A scheme administration member payment Is a payment for the administration or management of the scheme. Such payments should be made on an arm’s length, commercial basis. So any interest paid by a scheme on a refund of contributions should be no more than a reasonable commercial rate if it is to be a scheme administration member payment. Any excess will be an unauthorised member payment and taxed accordingly – see RPSM04104020 and RPSM04104040.

Interest payments associated with a short service refund lump sum that meet the definition of scheme administration member payment are taxable under section 369 Income Tax (Trading and Other Income) Act 2005 (formerly Case III Schedule D). The scheme administrator should make the payment without deducting income tax, and the recipient should include the interest in a self-assessment tax return or notify their HMRC income tax office of liability if they do not receive a notice to make a return.

Interest as part of the lump sum

If the contributions to be refunded are less than the statutory maximum then schemes may be able to provide for interest to be paid as part of the lump sum. For example, the lump sum may be computed with reference to an interest rate. If the interest is part of the lump sum, and the lump sum paid is within the statutory maximum, the tax treatment set out in section 205 Finance Act 2004 applies.