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Replies to Queries - 4 - Dentist's pension

20 January 2003
Issue: 3891 / Categories:

Our dentist client pays superannuation of 6 per cent on his health service income. In previous years, relief for superannuation payments has been foregone in favour of a claim for personal pension premiums on the statutory basis.

Our dentist client pays superannuation of 6 per cent on his health service income. In previous years, relief for superannuation payments has been foregone in favour of a claim for personal pension premiums on the statutory basis.

As he had a high level of earnings in 1999-2000, this year was nominated as the basis year for pension premium purposes (section 646B, Taxes Act 1988). His earnings for 2001-02 were below the earnings cap and his personal pension premiums paid in that year were 'related back' to the previous year. If our client claims relief in respect of his 6 per cent superannuation payments for 2001-02, he will have no net relevant earnings (because the superannuation payment, multiplied by 16.66 will exceed his total earnings). However, can he pay a personal pension premium in 2002-03, relate this back to 2001-02 and still obtain tax relief because 1999-2000 is the nominated basis year? Or is this too good to be true?

(Query T16,143) - Provider.

Where a personal pension contribution is carried back from 2002-03 to 2001-02, it is deemed to have been paid in 2001-02. This means that the client must have sufficient net relevant earnings in that year to cover the premium.

Ignoring the election for 1999-2000 to be the basis year as a result of the election under section 646B, Taxes Act 1988, if a taxpayer claims relief for superannuation contributions under Extra-statutory Concession A9, net relevant earnings must be restricted. The unadjusted figure for net relevant earnings is calculated and the next step is to apply the earnings cap of £95,400 for 2001-02 if appropriate. The earnings are less than the cap and so, as 'Provider' states, one multiplies the figure for superannuation contributions paid (excluding any added years element) by 100/6. This is deducted from the net relevant earnings for the year and only if the resulting figure is positive can a personal pension premium also be paid. This could be a premium paid in 2001-02 or an amount paid in 2002-03 and carried back to 2001-02.

As an example, let us assume that net relevant earnings are £70,000 and that 'Provider's' client is claiming relief on superannuation contributions of £4,500. In such a case, the notional superannuable earnings after applying the fraction of 100/6 comes to £75,000 and, as this exceeds the net relevant earnings, no personal pension premium can be paid.

However, the client has made an election (under section 646B) for 1999-2000 to be the basis year. If we assume that net relevant earnings for that year amount to £100,000, the situation will change.

As before, the first step is to apply the earnings cap, but the question is which year's cap should be applied? At first, the Inland Revenue indicated that the cap for the basis year, in this case 1999-2000, should be used irrespective of when the pension premium is paid. However, in Pensions Update 130 (23 April 2002), the Inland Revenue practice changed. From the date of the Update, one can apply the cap for the year in which the pension premium is paid, or deemed to be paid. Therefore the net relevant earnings, as restricted by the cap, will be £95,400, the cap for 2001-02, instead of £90,600, the cap for 1999-2000.

The notional superannuable earnings remain at £75,000 for this example and so the client has net relevant earnings of £20,400. The maximum contribution limit is applied to this figure and so 'Provider' will arrive at the maximum personal pension contribution that his client can pay.

Two final points are that the premium must be paid by 31 January 2003 if it is to be carried back and the carry back election must be made at or before the time that the contribution is paid. - Hodgy.

'Provider's' query gives an unusual example of the advantages open to taxpayers in manipulating their earnings in one year to give them high income for a basis period which can then be used to support substantial pension contributions for the following years.

The popular example of this is a director/shareholder in a personal trading company who pays himself a high salary one year in five to give a high basis year for pension contributions, and then pays a minimal salary and high dividends for the four remaining years to reduce his tax and National Insurance liabilities.

The situation here is very similar; the matter of carrying back the contributions is simply a minor complication. For the purposes of establishing when contributions can be related back, the only thing that matters is the availability of net relevant earnings. As such, the key question posed by 'Provider' appears to be whether there is any reason why relief should be denied on the superannuation contributions for a year simply because personal pension contributions are made in that year calculated by reference to a basis period established in a previous year, rather than that year's earnings.

In general, tax relief on superannuation contributions for doctors and dentists is given by Extra-statutory Concession A9. Although self employed, doctors and dentists have the opportunity to be members of a final salary pension scheme. Indeed membership is effectively compulsory, with employers' contributions made by the National Health Service and employees' contributions based on a notional 6 per cent of National Health Service earnings deducted at source. As tax relief cannot be given at source through pay-as-you-earn on these contributions, it has to be made available by extra-statutory concession. Doctors and dentists can receive tax relief, normally at 40 per cent, on the contributions via their tax returns in return for foregoing the opportunity to make personal pension contributions based on these earnings. Alternatively, they would not claim any tax relief on the superannuation contributions and so use the earnings to make personal pension contributions.

The main problem with Extra-statutory Concession A9 is that it was written prior to the new legislation on basis years and has not since been updated. As such, it appears to allow tax relief in a far more generous way than was originally intended.

Indeed, if, as is possible, there are no net relevant earnings in future years when National Health Service earnings multiplied by 16.66 are taken into account, it might be possible to simply disclaim tax relief one year in ten, a luxury allowed by section 646D, Taxes Act 1988. Although this privilege is not available to any holder of an office or employment providing a superannuation scheme, as stated above, the dentist's superannuation scheme does not fall within this definition. However, this scenario is unlikely as the superannuation payments tend to be slightly out of step with the figure of 16.66 times earnings. This means that there are likely to be net relevant earnings, albeit very small in at least one of these years (and thus falling foul of section 646D(5)(a)).

There also appear to be no flies in the ointment when sections 646B and 646C, Taxes Act 1988 are examined more closely. Section 646B appears to be concerned only with provision of evidence as to net relevant earnings, rather than whether the earnings actually exist. There appears to be nothing within either section to require earnings in later years to be used as a basis year if earnings in earlier years would suffice. As such, they also appear to offer no restriction on relief for both the superannuation contributions and personal pension payments.

In this case, the only problem for our dentist might be reluctance on the Inland Revenue's part to allow him the benefit of Extra-statutory Concession A9 and simultaneously make personal pension contributions based on an earlier basis year. The intention of the concession, although not its actual wording, is to treat the dentist as being part of an occupational pension scheme and therefore deny the ability to make personal pension payments using an earlier year's net relevant earnings as a basis period. Extra-statutory concessions are not intended to be taken advantage of purely in an attempt to reduce tax liabilities, and I suspect that if the dentist attempts to do this he is going beyond the spirit of Concession A9. However, It would be unusual for the Inland Revenue to deny the opportunity to take advantage of a concession. Therefore, although 'Provider' might wish to warn his client of the potential danger, I would consider any problems unlikely. - MP.

Issue: 3891 / Categories:
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