TAX NEWS - 2010

UK Emergency Budget

UK Emergency Budget - radical changes to high earner proposals

Yesterday's UK Emergency Budget included various pensions-related announcements. Of particular significance are changes to the proposals to reform the tax regime applicable to high-earners, and clarification that HMRC will scrutinise employer-financed retirement benefit schemes (EFRBSs) as potential tax avoidance mechanisms.

The UK Government has also been able to follow through on its earlier policy statements to end compulsory annuitisation by age 75 and in relation to state pensions.

The key pensions provisions in the Budget are summarised below.

1. High earners
2. EFRBSs
3. Annuitisation by age 75
4. Default retirement age
5. Public sector pensions
6. State Pensions
7. NEST

1. High earners:
High income excess relief charge likely to be scrapped
Proposals to reduce annual allowance
The Government gave a clear (but not entirely definitive) indication that changes to the tax regime applicable to high earners (and scheduled to come into force on 6 April 2011) will be scrapped. However, the Budget documentation is silent on the anti-forestalling provisions which, it is assumed, will remain in force in their current form until April 2011.

In broad terms, the post-April 2011 changes, proposed by the previous Government, would have led to the introduction of a "high income excess relief charge" on the pension savings of individuals with taxable incomes in excess of £150,000 (including the value of employer pension contributions in respect of that individual). This would have had the effect of reducing the tax relief applicable to the pension savings of affected individuals on a tapered basis, so that those with taxable incomes of over £180,000 would have received tax relief at the basic rate.

The Budget documentation notes that these proposals "could have unwelcome consequences for pension saving, bring significant complexity to the tax system and damage UK business and competiveness".

In a further indication that the high income excess relief charge will not be introduced, the Government announced its intention to introduce powers to repeal the provisions in the Finance Act 2010 which established the framework for the regime.

As an alternative to the previous Government's proposals, UK Government is inclined to reduce the annual allowance (the amount which can be contributed/accrued annually by or on behalf of an individual without incurring a tax charge – currently set at £255,000) to the region of £30,000 - £45,000.

The Government intends to engage with employers, schemes, experts and other interested parties to "determine the best design of a regime". However, given that they have already referred to a potential reduction in the annual allowance in fairly specific terms, it seems likely that they will proceed largely on this basis (perhaps in conjunction with reforms of other existing allowances).

It is thought that the Government's consultation will cover such areas as protection for certain individuals, compliance issues, how defined benefit accrual should be valued and the mechanism for paying any tax charges.

2. EFRBSs:
EFRBSs could fall foul of anti-avoidance provisions
Broadly, EFRBSs are unregistered retirement benefit schemes subject to distinct tax and National Insurance requirements. Many employers had been considering establishing EFRBSs as an alternative means of pension provision for their high earners, in order to lessen the impact of the proposed high income excess relief charge.

In the March Budget, UK Government announced "future action to tackle the use of arrangements to reward employees through the use of trusts and other intermediaries, with the purpose of avoiding, deferring or reducing liabilities to income tax or NICs or avoiding restrictions on pensions tax relief". The Government also stated that it would "consider options for tackling these avoidance arrangements with the intention of introducing any necessary legislation to take effect from April 2011." There was concern that these statements (and the accompanying anti-avoidance provisions in the Finance Act) could have applied to restrict the application of EFRBSs.

In yesterday's Budget, UK Government confirmed that EFRBSs are indeed within the scope of these anti-avoidance provisions. Legislation will take effect from April 2011.

This does not necessarily mean that EFRBSs will be considered to be tax avoidance vehicles in all circumstances. The detail contained in the forthcoming legislation will determine whether EFRBSs continue to be viable and tax efficient retirement benefit vehicles for high earners.

3. Annuitisation by age 75:
The existing requirement for pension scheme members to purchase an annuity by age 75 will end from April 2011. A consultation on the detail of this change will be launched "shortly".
There will be legislation for transitional arrangements for those yet to secure an income but who will reach age 75 in the meantime. These, in essence, defer the effective requirement to buy an annuity to age 77.
Similar transitional arrangements will apply for the purposes of certain inheritance tax charges.

4. Default retirement age:
The Government will consult "shortly" on "how it will quickly phase out the default retirement age" from April 2011.

5. Public sector pensions:
The Government confirms that the independent commission, chaired by John Hutton, will undertake a "fundamental, structural review of public service pension provision" by the time of the Budget in 2011.
It will also consider the case for short-term savings by September 2010.
UK Government will use the Consumer Prices Index (CPI), instead of the (normally higher) Retail Prices Index (RPI), for the indexation of public service pensions from April 2011.

6. State Pensions:
With effect from April 2011, the basic State Pension will be uprated by a "triple guarantee" of the highest of earnings, prices or 2.5%. The "prices" aspect of this guarantee will in future be based on the CPI, except for indexation in April 2011 (which will be based on RPI).
The Government also indicated that the State Second Pension will also be increased in line with the CPI.
The standard minimum income guarantee will increase in April 2011 by the cash rise in a full basic state pension.

7. NEST:
Emergency Budget provides for the National Employment Savings Trust (NEST) to be registered with HMRC for tax purposes. This suggests that, notwithstanding the Government's internal review of the scope of auto-enrolment and NEST, it remains committed to the basic tenets of the regime.