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Candid Contributions - II

04 December 2002 / Keith M Gordon
Issue: 3886 / Categories: Comment & Analysis

KEITH GORDON MA, ACA, CTA examines the tax rules relating to personal pension contributions.

KEITH GORDON MA, ACA, CTA examines the tax rules relating to personal pension contributions.

IN PART I of this two-part article, I looked at the current rules applying to contributions to personal and stakeholder pension schemes following the changes introduced by Finance Act 2000. Most of what was written related equally to the rules that existed before 6 April 2001, the earnings threshold being an exception. However, under the old rules, complex provisions allowed entitlement to relief to be carried forward for up to six years, and contributions to be treated as if they had been made in the previous year, and in some cases as if they had been made in earlier years.

These were especially useful for those who did not know what their net relevant earnings were until after the tax year was over and so did not necessarily have time to make the appropriate contributions to their pension scheme.

There is still some scope for treating contributions as paid in an earlier year, and this is discussed further below. The carry-forward rules, however, have been scrapped completely and replaced by a set of rules that allows one year's relevant earnings figure to be retained for five years, notwithstanding a fall in the level of earnings.

The five-year rule

A wholly innovative aspect of the new rules allows individuals to contribute to their pension scheme based on a historical figure for relevant earnings.

In the simplest case, it allows a taxpayer to nominate a tax year, known as the basis year, and allow contributions to be based upon the net relevant earnings of the basis year during the following five tax years (section 646B(4)).

Although the rules were introduced with effect from 6 April 2001, it appears that the basis year can be one before 2001-02. See Example 1. Furthermore, it is not necessary that the individual was a member of the pension scheme at any time during the basis year (section 646B(3)). This allows, for example, taxpayers to join a pension scheme and choose a basis year after a successful year.

Example 1

Everdene wishes to make the maximum contributions to her pension scheme even though her current earnings are modest compared with a highly successful year in 1999 (assessable in 1999-2000).

Everdene may nominate 1999-2000 as her basis year. This nomination can be used from 2001-02 until and including 2004-05, but not in 2000-01 as the rules did not apply before 6 April 2001.

A basis year may only be nominated, however, if the taxpayer provides the pension company with evidence of his income that make the net relevant earnings in the basis year (section 646B(1) and (2)).

Once a basis year has been chosen, this will stand for the next five years. It does not preclude a new basis year being nominated during that period. If the later basis year has higher net relevant earnings than the earlier basis year, then the new basis year will have immediate effect (section 646B(8)). Otherwise, the later basis year will only have effect once the first basis year expires (section 646B(9)). See Example 2.

Example 2

Everdene from Example 1 has another successful year in 2003-04 and wishes to make that a basis year.

If the net relevant earnings for 2003-04 exceed those in 1999-2000, the net relevant earnings in 2003-04 will stand for the years 2003-04 to 2008-09.

However, if the 1999-2000 figures still exceed those in 2003-04, the net relevant earnings in 1999-2000 will continue to apply for 2003-04, and 2004-05, but the 2003-04 figures will be used in 2005-06, 2006-07, 2007-08 and 2008-09.

The earnings cap does not limit the figure for the net relevant earnings for years subsequent to the basis year. Instead, the cap is imposed after the net relevant earnings are calculated for a particular year (section 640A(1)). See Example 3.

Example 3

Everdene had net relevant earnings in 1999-2000 of £96,000 which are above the earnings cap (£90,600) that applied that year. Similarly, in 2001-02, the cap (£95,400) exceeds the net relevant earnings and so applies to limit contributions.

However, in 2002-03, the earnings cap is higher than the net relevant earnings. Thus the previously suppressed earnings figure (£96,000) can be used without limit.

Retaining a basis year

In limited circumstances, a basis year can have effect for more than five years after the basis year itself. This will occur if:

  • an individual has a tax year in which he has no true (rather than deemed) relevant earnings;
  • the individual did have true relevant earnings in the previous tax year; and
  • either in that previous tax year (and/or in one or more of the five tax years before that) the individual was entitled to contribute to the scheme more than the earnings threshold for that year (section 646D(1)).

In such circumstances, the first tax year without relevant earnings will be known as the break year and the tax year immediately preceding it the cessation year. The cessation year and the five tax years immediately preceding it are known as the reference years.

For the break year and the next four tax years (section 646D(4)), it is possible to nominate a basis year from any of the reference years (section 646D(2)). It is therefore possible for, say, 1999-2000 to be a basis year for 2009-10, some eleven years later.

This will only apply, however, if in these later years (the post-cessation years) the individual:

  • has no true relevant earnings;
  • is not a member of an employer's pension scheme; and
  • satisfies the above two conditions in each (if any) of the previous post-cessation years (section 646D(5)).

Early treatment

For any pension contributions paid after 5 April 2001, a new set of provisions applies if the contribution (or any part of the contribution) is to be treated as paid in an earlier year. Thus the contribution is set against the maximum contribution applying in the earlier tax year (section 641A(2)).

This only applies if the contribution is made before 1 February in the tax year (section 641A(1)), so contributions made after 31 January and before the next 6 April can only be treated as having been made in the tax year they are actually made.

Furthermore, the taxpayer must make an election to relate the contribution back to the previous year when or before the contribution is made. This is an irrevocable election (section 641A(1)).

Unlike the previous rules, the new provision only allows contributions to be related back to the immediately preceding tax year (section 641A(1)). Previously, a contribution could be related back to the one year before the immediately preceding tax year when there were no relevant earnings in the intermediate year. Since the entitlement to make contributions is no longer dependent on the existence of relevant earnings, the new simpler rule is sufficient.

It also appears that the new rules put to bed the question that occasionally arose under the old rules when there was a change in the basic rate of income tax in the two years affected by an election. Since an election may no longer be made after the contribution is made by the individual, it seems clear that the basic rate deduction should be made at the rate applying in the tax year to which the contribution (or part of it) relates.

Effect on tax bills

Under the key principle of self assessment, the relating back of a pension contribution does not result in the previous year's tax affairs being re-opened. Instead a calculation is made to ascertain what would have been the tax liability in the earlier year had the contribution been made in the earlier year and this is compared with the actual liability for the year. The difference is then treated as a credit to the taxpayer's account in the later year (paragraph 2(1), (4) and (6) of Schedule 1B to the Taxes Management Act 1970.)

The effect on a taxpayer's payments on account is particularly significant. In general, the total amount deemed to have been payable on account is the lower of:

  • the total liability to tax (excluding tax deducted at source) in the year in question; and
  • the total liability to tax in the previous year.

However, relating contributions back to an earlier year means that repayments are taken out of the reckoning for the purposes of payments on account. This is demonstrated in Example 4.

Example 4

Oak makes pension contributions which ensure that:

    • his tax liabilities are £10,000 in 2001-02, £12,000 in 2002-03 and £15,000 in 2003-04 without relating back contributions; and
    • as above, but £2,500 worth of relief is related back from 2002-03 to 2001-02.

In the basic case, Oak's payments on account for 2002-03 are therefore £5,000 on each of 31 January and 31 July 2003 and, for 2003-04, £6,000 on each of 31 January and 31 July 2004.

In the alternative case, it is not simply a matter of reducing the liabilities in 2001-02 and increasing the liabilities in 2002-03 by £2,500 with a consequent reworking of the payments on account at £5,000 and £6,000.

Instead, although the £2,500 would be relieved, the payments on account would remain unchanged.

Making an election

If pension contributions have been related back to the previous year, a note should be made in Box 14.7 of the tax return. This is to ensure that they are not relieved in the later year's tax calculation.

Similarly, it is possible to accelerate the timing of relief in respect of contributions of later years being related back to the year for which the return is being prepared. For example, on the 2002 tax return, there is a box (14.8) for contributions paid between 6 April 2002 and 31 January 2003 inclusive. This will require entries to be made in Boxes 18.5 and 18.8 respectively to show the relief being claimed in the earlier year.

However, one improvement on the system has recently been announced. In Issue 10 of the Revenue's Working Together newsletter, the Revenue announced that entries in Boxes 18.5 and 18.8 will be processed automatically, thereby alleviating the previous delays that arose.


Keith Gordon is a director of ukTAXhelp Ltd, a company specialising in providing tax advice to other professional businesses. He can be contacted by e-mail on The views expressed in this article are those of the author.


Issue: 3886 / Categories: Comment & Analysis
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