Bill Birmingham looks at how the new UK Finance Act, coming into force in April 2006, will simplify the pension regime in the UK
The UK Finance Act 2004, which received Royal Assent on 22 July 2004, introduces a new unified, and allegedly simplified, tax regime for UK pension arrangements. The new regime will come into operation on 6 April 2006.
Under the new regime, pension schemes will be required to register with the Inland Revenue if they are to obtain tax advantages, though existing tax approved schemes will receive automatic registration. Unregistered schemes may continue to operate, but they and their members will, in general, no longer obtain the limited tax reliefs that they currently receive under the current unapproved scheme regime. However, Section 615 schemes - trust schemes established in the UK to provide benefits for person's employment outside the UK - are unaffected by the changes and may continue as now.
The act replaces the existing raft of statutory and discretionary requirements that different varieties of schemes must satisfy to obtain tax advantages by a single statutory code applicable to all registered pension schemes. The new rules remove the current restrictions on maximum levels of contributions and/or benefits and who may participate in the scheme. Instead, the act imposes, subject to transitional protection, a 25% charge on any benefit derived from an individual's aggregate registered pension arrangements in excess of a standard lifetime allowance (£1.5m for 2006/07). With the member's income tax liability this will amount to an effective tax charge of 55%. In addition, where the increase in the value of an individual's pension rights in any one year, apart from the year in which the person draws all their rights under a pension arrangement, exceeds that year's annual allowance (£215,000 for 2006/07), the individual loses tax relief on the excess.
Overseas members of UK registered pension schemes
Under the current regime applicable until 5 April 2006, an employee working abroad under a contract of employment with a UK employer from whom they receive remuneration may remain a member of the employer's tax advantaged occupational pension scheme. However, where an employee is transferred abroad to work for a non-UK employer, they may remain a member of the UK employer's scheme only if the transfer is temporary and either there is a definite expectation that the employee will return to the UK to resume employment with the scheme's sponsoring employer or to retire, or their earnings remain chargeable to UK tax. In such cases the UK employer must be reimbursed by the foreign employer for contributions to the scheme and the period of service abroad must not exceed 10 years.
From 6 April 2006, the Finance Act will permit non-UK residents and their employers to participate in, and contribute to, any UK pension arrangements, whether defined benefit or defined contribution, occupational or personal pension schemes, without the need to satisfy the current conditions for temporary secondment. However, the member can obtain tax relief on their contributions only if they are a 'relevant UK individual'. To be a 'relevant UK individual' in any tax year, an individual must satisfy one of four alternative conditions. These are:
• Firstly, during that year, the individual has UK earnings chargeable to tax.
• Secondly, at some time during the year the person was resident in the UK.
• Thirdly, the person, or spouse, has taxable earnings from Crown employment abroad during the year.
• Fourthly, the person was resident in the UK both at some time during the previous five tax years and when becoming a member of the scheme.
The maximum tax relief to which a 'relevant UK individual' may be entitled is, subject to the annual allowance, the amount of that person's UK earnings chargeable to tax in that year, or £3,600, if higher. Thus, the maximum amount of relief available in any tax year to a member working abroad, but with no UK taxable earnings, is £3,600. However, in such cases the relief is available only if the member can obtain relief under the 'relief at source' arrangements.
The Act defines an 'overseas pension scheme' as a scheme, other than a registered scheme, established outside the UK that satisfies requirements yet to be approved. It is a 'recognised overseas pension scheme' if it is recognised for tax purposes in the state where it is established, that state being an EU or EEA state, a state with which the UK has concluded a double taxation treaty or, provided the scheme satisfies stricter requirements, certain other states. A 'recognised overseas pension scheme' may apply to the Inland Revenue to become a registered scheme, for example, where it has UK employees, if it is an occupational pension scheme or is established by an EU or EEA financial institution. If it becomes registered, it becomes subject to the same statutory conditions as a UK registered scheme.
Qualifying overseas pension schemes
An overseas pension scheme is a 'qualifying overseas pension scheme' if it has provided evidence to the Inland Revenue that it is an overseas scheme and has given certain undertakings to the Inland Revenue. A 'relevant migrant member' of such a scheme is a person who was not resident in the UK when first becoming a scheme member, was a member at the start of a period of UK residence that includes the time when contributions are paid, and before that period was entitled to tax relief in the country in which they were then resident. If such a member has relevant UK taxable earnings in a tax year, is resident in the UK when pension contributions are paid, and has informed the scheme manager of an intention to claim tax relief, they can obtain UK tax relief on the contributions paid during a tax year. Nor is the member liable for income tax on any contributions that their employer pays on their behalf.
A UK employer who pays contributions to a qualifying overseas pension scheme in respect of a relevant migrant member obtains the same tax reliefs as if the contributions had been paid to a registered pension scheme, in other words they are tax deductible in computing the amount of the employer's profits for the period of account in which they are paid.
Where a relevant migrant member has obtained tax relief on contributions to a qualifying overseas pension scheme, the rights that accrue as a result of those contributions count towards the member's lifetime allowance, and also count as input towards the annual allowance.
Enhancement of lifetime allowance for relevant overseas individuals
The act defines a person as a 'relevant overseas individual' at any time if they are either not a 'relevant UK individual' or is a 'relevant UK individual' solely by reason of being a UK resident at some point in the previous five years, if they are not employed by a UK employer. If at any time between the date when a person began to accrue benefits (or 6 April 2006, if later) and the date when a pension becomes payable, an annuity is purchased or rights transferred to a foreign scheme the person is a 'relevant overseas individual', their lifetime allowance is enhanced by the increase in value of their rights for the period during which they did not obtain UK tax relief.
Where the value of the crystallised rights of a registered scheme member exceeds the lifetime allowance, the Act imposes a lifetime allowance charge jointly and severally on the individual and the scheme administrator. However, where the individual is a member of a non-UK scheme, contributions to which have obtained UK tax relief, the liability is imposed solely on the individual.
Transfers to and from an overseas scheme
The act permits transfers to be made from a registered pension scheme to another registered pension scheme or to a 'qualifying recognised overseas pension scheme', in other words an overseas scheme that has undertaken to the Inland Revenue to comply with prescribed disclosure requirements. A transfer to a qualifying recognised overseas pension scheme constitutes an event which requires the value of the member's accrued rights to be set against the lifetime allowance.
A transfer may also be made from a recognised overseas pension scheme to a registered pension scheme. In such cases the lifetime allowance may be enhanced by the value of the rights transferred less the amount in respect of which the member obtained UK tax relief.
Action before A-Day
In the absence of the consequential regulations, it is not possible to obtain a full picture of how the post-6 April 2006 tax regime will impact upon pension scheme members and pension schemes outside the UK. Nevertheless, such members, their employers and scheme trustees should be starting to consider what, if any, changes they may need to make to their current pension arrangements to take account of the changed, simplified tax regime for non- UK participation.
The UK Finance Act 2004 was an attempt to introduce a simpler tax regime for all UK pensions.
Schemes that do not register with the Inland Revenue under the new regime can continue but will lose many advantages.
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Lifetime and annual allowances