Surplus Avoidance Scheme

HMRC is aware of an avoidance device that seeks to take advantage of a combination of rules within the pensions tax legislation to allow a member of a registered pension scheme to extract the funds from their pension scheme tax-free.

We have examined this in detail and our considered view is that the avoidance device does not succeed in its aim of extracting funds out of a pension scheme without incurring tax charges and that unauthorised payments tax charges will apply. We, therefore, want to stress to scheme administrators what the tax implication will be if this type of transaction is undertaken.

In April 2006 the Government introduced a new, simplified, regime for the taxation of pensions. HMRC are committed to monitoring the new regime to ensure practice remains in line with the original intentions. If schemes are uncovered which attempt to step around the rules to create a tax advantage the Government will not hesitate to act.

The Government has made clear that it provides generous tax reliefs to support saving to produce an income throughout retirement. HMRC will take very careful note of schemes which seek to divert the purpose of the new regime or to use pension tax reliefs for purposes other than the one for which they were intended.

Details

For obvious reasons we do not want to set out the full details of the device but in short it purports to create a tax-free payment by artificially creating a surplus within a registered pension scheme through a member surrendering their pension rights. It was suggested that this would then create a tax-free payment by making a surplus payment in a specified way.

HMRC wishes to make clear that a payment to a sponsoring employer arising out of a surplus generated by a pension scheme member surrendering their pension benefits is not an authorised surplus payment within section 177 Finance Act 2004 as prescribed in the Registered Pension Schemes (Authorised Surplus Payments) Regulations SI 2006/574 (the Surplus Regulations).

A payment made in these circumstances is therefore an unauthorised employer payment and as such is subject to income tax charges of up to 70 percent. The scheme will, in addition, still be liable for the provision of the benefits 'surrendered'.

The authorised surplus payment tax rules are built upon Department of Work and Pensions (DWP) legislation that regulates the payment of surpluses to employers from occupational pension schemes.

For schemes that are not in wind- up, under section 37 Pensions Act 1995 (PA95), a payment to the sponsoring employer can only be considered if a scheme is funded above a full buy-out level. Alternatively under section 76 PA95, when a scheme winds-up it first has to secure all the scheme's liabilities and there has to be a surplus of assets over those liabilities for a payment to the employer to be considered. A surplus cannot be created by a reduction in liability caused by members surrendering their rights in a scheme because under section 91 PA95 members cannot make an enforceable surrender of their pension rights except in clearly defined circumstances, none of which would apply in this situation.

Any attempt by an employee to surrender their rights to any pension is unenforceable so there is no surplus that satisfies the requirements of section 37 or section 76 PA95. Therefore, no authorised surplus payment can be made to the employer under the tax rules.

HMRC can confirm that the position is the same for those occupational schemes that are not governed by either section 37 or section 76 PA95. As the Surplus Regulations provide that the same rules apply to these schemes.

If you have any questions about this article please contact Matthew Clapp on 0115 974 1505.