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Pensions and self-assessment

When a pension premium is paid there are two ways to obtain tax relief:

Against the profits of the tax year in which the premium is being paid, or

To make an election for it to be treated as a premium paid in respect of the previous year

However both of these methods are claims in respect of the current tax year. Consequently the second option does not lead to a reduction in the liability for the previous year but to a credit or repayment in the current year that is calculated according to the rates and income for the previous year.

Under self-assessment the initial payments on account are based on the liability of the previous tax year. Thus a premium paid that results in the reduction of the liability for a tax year also reduces the initial payments on account for the following year. The effect is either that relief is obtained against the payments on account for the similar premium paid the following year or if no premium is paid that part of the liability is postponed until the balancing payment of the 31^st January following the tax year. Prior to self-assessment payments related back were allowed against the assessment of the previous year.

This is best illustrated by examples:

Note for simplicity we have assumed no allowances or deductions and a single 40% tax rate, obviously the effects of moving in and out of the various rates of tax will have additional implications but we consider these must be considered on an individual basis. The examples also assume a year end of 5^th April and that the business ceases 5^th April 2000

Alan Apricot has profits of £100,000 in 1995, which increase by £10,000 pa and pays pension premiums of £10,000 pa on 1^st January, he claims relief against the profits of the year in which the premium is paid:

Beryl Blueberry has profits of £100,000 in 1995, which increase by £10,000 pa, and pays pension premiums of £10,000 pa on 1^st January, she claims relief against the profits of the year prior to that in which the premium is paid:

Note that if the final premium of £10,000 is not paid on 1^st January 2001 (nearly nine months after ceasing to trade) the final credit on premium will not arise and the balance of tax would be £4,000. This illustrates a general problem with paying premiums in arrears – namely funding them once the business ceases.

Charlie Cucumber has profits of £100,000 in 1995, which increase by £10,000 pa, and pays pension premiums of £10,000 pa on 1^st January 1997 (carry back against 1995/96), £20,000 on 1^st January 1998 (£10,000 carried back, balance against current year) and £10,000 on 1^st January 1999 and 2000

Daphne Damson has profits of £100,000 in 1995, which increase by £10,000 pa, and pays pension premiums of £10,000 pa on 5^th April, she claims relief against the profits of the year prior to that in which the premium is paid:

It is necessary for Daphne to pay the full balance of tax due on the 31^st January following the year of assessment because she has not then actually paid the pension premium related back. On payment of the premium and submission of details to the Inland Revenue a repayment will be received

In the past many taxpayers have carried back pension premiums and in effect obtained tax relief prior to payment. This will no longer be possible. Obviously there will be a cash-flow disadvantage compared with previous practice.

All other things being equal (i.e. relief being obtained at the same rate in each year) we continue to favour the carry back of premiums where possible.

If premiums are being claimed against tax in the year in which they are paid then the relevant tax points are:

Pay the premium as late in the year as possible (i.e. just before 5^th April) so as to maximise cash-flow advantage,

Prior to 31^st January in the tax year review the level of premiums you intend to make, the likely taxable profits and the payments on account due to determine whether an application should be made to reduce the payments on account.

If premiums are being carried back then the tax considerations that may effect the date of payment are as follows:

payments made and notified to the revenue as carry-back claims prior to 31^st July can reduce both the second payment on account (due 31^st July) and the balancing payment (due 31^st January),

payments made and notified to the revenue as carry back claims prior to 31^st January can reduce the balancing payment,

In most cases however the balance of advantage probably still remains with leaving the payment until 5^th April unless the combination of paying the tax due and the pension premium then waiting for the refund would result in borrowing that would otherwise not arise.

The above relates solely to tax consideration and you should bear in mind that there may be investment implications that would justify earlier payment of the premiums. Each taxpayer is an individual and as such your particular circumstances need more detailed consideration than can be afforded by the general guidance above. If you wish to discuss this further please contact Ian Fletcher.

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