Consultation on employer asset-backed contributions

Introduction

Following a trailer in this year’s Budget,1on 24 May 2011 the Government issued a consultation on changing the tax rules relating to employer asset-backed contributions to DB pension schemes.

In this Alert:

• Key points
• Background
• The issue
• Some examples
• Proposals
• When will the new rules apply?

Key points

• The proposed changes will limit tax relief to the fair value of assets received by the pension scheme.
• However, the Government intends to preserve flexibility for employers and schemes to use these arrangements to manage deficits.
• The aim is to publish draft clauses in the autumn and introduce new legislation in the Finance Bill 2012.
• The consultation, to which we will respond, closes on 16 August 2011.

Background

Pressing economic conditions have forced employers to seek increasingly creative solutions to funding their DB scheme deficits. One such solution is asset-backed contributions. Typically, these involve a series of payments guaranteed with security over the assets from which the payments derive.

Such arrangements allow an employer to use non-cash assets to underpin regular cash contributions or income streams to its pension scheme. They can also allow employers to agree longer recovery plans.

These structures are also attractive to pension schemes as they come with additional security, providing a right to the underlying asset should the employer become insolvent or the income stream cease.

The issue

Recognising the flexibility asset-backed contributions provide for employers and pension schemes, the Government does not intend to inhibit their use. However, it is concerned that some asset-backed funding arrangements may give rise to tax relief that is greater than the fair value of the assets received by the scheme. It is also keen to ensure that pension scheme funding decisions are not driven by the tax treatment of the different arrangements at the employer’s disposal.

Some examples

When an employer makes a simple asset transfer to a pension scheme (for example, in lieu of a cash contribution of £400 million it transfers a business property to the scheme which is worth the same amount) the tax treatment for the employer is exactly the same as if it had sold the property and contributed cash to the scheme.

However, by introducing more complex arrangements which do not involve an upfront contribution but a stream of payments incorporating some element of contingency, the Government believes that the employer’s tax relief may be:

• given before a contribution is received by the scheme;
• doubled as a result of mismatches between accounting and tax rules; and
• retained even though the value of the payments actually received by the scheme is much lower than the tax relief given to the employer.

Proposals

The Government is consulting on two options which would limit the amount of tax relief available to employers when using asset-backed contributions.

Option A – providing relief only when cash is received by the scheme

This involves removing automatic upfront tax relief for asset-backed contributions. Instead, employer tax relief would be given only as and when the scheme actually receives each cash payment from the arrangement.

This option is likely to increase the administrative burden on employers and pension schemes. They would need to decide, and possibly agree with HMRC, whether an asset is sufficiently close to cash to warrant tax relief upfront in the ordinary way or not.

Option B – aligning tax rules with accounting rules

Existing tax rules would be amended to ensure that the tax treatment of the arrangements as a whole (not just the part that governs tax relief for pension contributions) accurately reflect the economic substance of the transaction. Therefore, the tax treatment of an arrangement would generally follow relevant accounting rules over the period of the arrangement.

Where an arrangement is recognised as a financial liability in an employer’s accounts, upfront tax relief based on the accounting value of the asset would be available. In contrast, if the arrangement is accounted for as equity, upfront tax relief would not be available.

As most employers would continue to follow existing accounting and tax rules, this option is not anticipated to create undue administrative or compliance costs. Therefore, Option “B” is the Government’s preferred route because, in its view, it most effectively balances its objectives of removing excess tax relief while maintaining the flexibility of asset-backed contributions.

When will the new rules apply?

Neither option would affect the tax treatment of straightforward cash contributions or the outright transfer of non-cash assets. In addition, the good news is that any tax relief already given on the basis of the current rules would not be unpicked. Nonetheless, the new rules will apply to amounts that arise after they come into force, including payments that become due under existing arrangements after the rules are enacted.

1 Please see our Alert: “To the Budget 2011… and beyond!” dated 24 March 2011