Your company client usually pays large employer pension contributions for its directors but doing this now will cause a loss to arise. Is it still worthwhile to do so, or should alternative arrangements be made?

Employee or employer to pay?

Whether your clients pay pension contributions personally or arrange for their company to pay them, they qualify for tax relief. As a rule of thumb, it’s more tax efficient for a company to pay employer contributions, especially if this is being done as part of a profit extraction strategy. However, if the company doesn’t have enough profits to cover them, will it be more advantageous for your clients to pay them personally instead?

Timing of relief

Before considering the tax effects of pension contributions you need to make clients aware of the special rule which determines when a company is entitled to a tax deduction. Where a company pays employer contributions it’s entitled to deduct the cost from its profits for corporation tax (CT) purposes.

However, 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 2019 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 2019, 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 2020 it can claim CT relief against its profits for the year ended 31 December 2020.

Pro advice. A further rule operates to spread the relief, but this won’t apply unless the contributions exceed £500,000 in a year.

Loss making

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 the company’s CT bill for the previous year. There is also scope to use group relief to transfer losses to another group company, though this is unlikely to be relevant to small company clients.

If your clients choose not to carry back the loss it’s automatically carried forward and used to reduce the company’s taxable profit in later years. As long as the 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 the directors to personally pay them. There is therefore no need to change the contributions strategy.

Pro advice. Don’t forget that contributions made by an employer need to be included when considering the annual allowance. If total contributions exceed the available amount, a tax charge will apply. In some circumstances, it might be possible for your client to ask the scheme to pay any charge (see Follow up ).

Advise the client that it will still be more beneficial for the company to make the pension contributions. If this creates a loss, this can be relieved against previous or subsequent profits, as long as there will be sufficient profits to utilise the loss there is no need to change the payment strategy.