Understanding Corporation Tax relief – pension spreading rules

Pension spreading rules aim to prevent companies from drastically reducing their Corporate Tax liability in a single year by making exceptionally large pension contributions. Instead of allowing full relief in the year of payment, these rules defer part of the relief over multiple accounting periods.

These rules, governed by sections 197-199A of the Finance Act 2004, apply when a company’s pension contributions exceed a certain threshold compared to the previous accounting period.

General rule for deductibility

Under standard tax rules, an employer’s contributions to a registered pension scheme are deductible in the year of payment, not when recognised in the accounts. However, when a pension contribution is significantly higher than in previous years, the spreading rules may apply.

Criteria for spreading

The spreading rule applies if both of the following conditions are met:

✔ The pension contribution in the current year exceeds 210% of the contribution made in the previous accounting period.

✔ The ‘excess’ contribution is at least £500,000.

How the contributions are spread

Once the rules apply, the excess contribution is spread over multiple years:

• ‘Excess’ contributions between £500,000 and £999,999 are spread over two years.

• ‘Excess’ contributions exceeding £1 million are spread over three or four years, depending on the amount.

Consider a company that made pension contributions of £100,000 in 2023 and decides to make a sizeable £700,000 contribution in 2024.

Step 1: Determine if spreading applies

• 2023 contributions: £100,000.

• 2024 contributions: £700,000.

• 210% of 2023 contributions: £100,000 × 210% = £210,000.

Since the 2024 contributions (£700,000) exceed £210,000, spreading rules apply if the excess is at least £500,000.

Step 2: Calculate the ‘excess’ contribution

• 110% of 2023 contributions: £100,000 × 110% = £110,000.

• ‘Excess’ contribution: £700,000 – £110,000 = £590,000.

Because the excess is greater than £500,000, the contribution must be spread.

Step 3: Determine the spreading period

• Since the excess is between £500,000 and £999,999, the spreading period is two years.

• Half of the excess is deductible in the current year, and the other half is deferred.

Step 4: Calculate deductible amounts

• 2024 Deduction: £110,000 (110% of 2023 contributions) + £295,000 (half of excess) = £405,000.

• 2025 Deduction: Remaining £295,000.

Interestingly, if the company had contributed £600,000 instead of £700,000, there would be no spreading because the excess would be £490,000, which is below the £500,000 threshold. This means the company could have received greater Corporation Tax relief in 2024 by making a small contribution!

This highlights the importance of strategic tax planning. By adjusting the timing and amount of pension contributions, companies can optimise tax relief while maintaining flexibility in cash flow. For example:

✔ Instead of making a £700,000 contribution, the company could have contributed £600,000 in 2024 and deferred an additional £100,000 contribution to 2025.

✔ This would have preserved liquidity and reduced the Corporation Tax payment due for the 2024 year (assuming the company generated taxable profits) by nearly £50,000 compared to making the full £700,000 contribution in 2024.

When advising on large pension contributions, it is essential to consider the pension spreading rules. They are not widely known and could result in some unexpected consequences for the contributing company. Understanding these rules ensures that tax planning strategies are both effective and aligned with cash flow considerations.

If you need expert guidance on how these rules will affect your company, contact us here..