Gerry Brown takes a look at an example of how people can fall foul of pension rules and incur hefty tax charges
In 2001 Mr Kent transferred £55,354 from two approved personal pension schemes to the Holme Limited Pension Plan, a HMRC approved occupational pension scheme. It was clear that both personal pension schemes permitted transfers to approved occupational schemes.
HMRC was of the view that Holme Limited and the Holme Limited Pension Plan had been established to achieve pension fund liberation (or pension busting). HMRC believed that the scheme operators persuaded persons who wished to realise their pension funds before retirement age to become sham employees of Holme Limited. The employee would then request the transfer of pension funds from his legitimate approved pension schemes to the Holme Plan.
The transferred funds were used to buy an annuity which could then be used as security for an interest-free loan. The idea, HMRC alleged, was that the annuity would never be paid to the employee but similarly the loan would never be called in. If successful, the scheme would therefore leave the participators with 80% of the pension fund value as cash almost immediately on implementation, as opposed to 100% of the fund inaccessible until retirement age.
HMRC alleged that the payment to Mr Kent was an unauthorised scheme payment. As the law stood in 2001-02, the payment was treated as income of the member and the £55,354 was assessed to income tax on Mr Kent who appealed. His appeal was eventually heard by the tax tribunal.
The Holme Plan conditions included the following:
“The trustees may at the request of a member accept from the administrators of any fund scheme…..any transfer of monies (‘transfer value’) in respect of the member ……”
(‘Member’ clearly meant an employee of Holme Limited.)
“An employer may in its absolute discretion invite any one of its employees who has not attained the normal retirement age to become a member of the plan…….”
All parties were agreed that the Holme Plan required Mr Kent to be an employee of Holme Limited in order to be a member of the Holme Plan. The transfer of Mr Kent’s funds from the two schemes to the Holme Plan was only authorised by the rules of the two schemes if he was an employee of Holme Limited.
Was Mr Kent an employee? An employment is a contract of service (as opposed to a contract for services).
The Tribunal examined employment law quoting extensively from the leading case of Ready Mixed Concrete (South East) Ltd v Minister of Pensions and National Insurance  2 QB 497.
“A contract of service exists if these three conditions are fulfilled. (i) the servant agrees that, in consideration of a wage or other remuneration, he will provide his own work and skill in performance of some service for his master. (ii) He agrees, expressly or impliedly, that in the performance of that service he will be subject to the other’s control in a sufficient degree to make that other master. (iii) The other provisions of this contract are consistent with it being a contract of service.”
What happened next?
What did Mr Kent actually do? Although he apparently had a written contract of employment, this was never adhered to. The ‘job’ involved selling brochures on a commission basis but Mr Kent didn’t sell any. He didn’t earn any commission. The Tribunal determined that he didn’t even receive his basic salary of £160 per annum. The contract stated; “There are no fixed hours of employment but you will be expected to devote such of your time to work as may be required to achieve the necessary standards as discussed with your area manager.”
There was no evidence that there were any area managers or discussions in which minimum hours would have been set. The Tribunal formed the view that Mr Kent was not required by his alleged contract of employment to devote any time to work and in particular to selling the brochures. In the terms of the Ready Mixed Concrete case, there was neither ‘consideration’ nor ‘control’. The contract was a sham.
The Tribunal had little difficulty concluding that Mr Kent was not an employee of Holme Limited and was therefore not entitled to membership of Holme Plan. The transfer was an unauthorised payment.
To add insult to injury HMRC levied a penalty of £5,557 being 30% of the tax underpaid (Kent hadn’t disclosed either the ‘employment’ with Holme Limited or the transfer in the relevant self assessment return.) The tribunal considered the level of penalty appropriate. The current legislation on unauthorised payments imposes an income tax charge at 40%, based on the value of the unauthorised payment. There could also be a surcharge and a scheme sanction charge depending on circumstances.
Gerry Brown is tax and trusts manager at Prudential
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