Tech talk

Defined Benefit Transfers and the Annual Allowance - TT21/06

The recently issued Pensions Simplification Newsletter 14 has thrown up an unexpected interpretation of part of the Finance Act 2004. The particular part is section 236(4) and 236(5) which state:

"236 Defined benefits arrangements: adjustments of closing value (4) Subsection (5) applies if, during the pension input period, there is a transfer relating to the individual of any sum or asset held for the purposes of, or representing accrued rights under, the arrangement so as to become held for the purposes of, or to represent rights under, any other pension scheme that is:

(a) a registered pension scheme, or
(b) a qualifying recognized overseas pension scheme.

(5) The aggregate of the amount of any sums transferred and the market value of any assets transferred is to be added."

It seems clear to us that the correct interpretation of s236(5) is that the amount of the transfer value should be added to the deemed amount of the closing benefits, (which will be 'nil' since the benefits have been transferred out). The closing value will therefore be the amount of the transfer value (expressed in monetary terms).

However in the Newsletter the Revenue suggest a different interpretation, namely that the closing value should be expressed and calculated in the same way as the opening value, i.e. 10 times the pension entitlement (plus the amount of any separate lump sum entitlement). Thus the transfer will be neutral from an annual allowance point of view.

This may well be what the legislators intended but it seems clear to us that it is not what the legislation says.

The following example may help to illustrate the issue:

Client has a preserved pension of £50,000pa, and tax free cash is by commutation. The value was at the last scheme anniversary. Transfer value £800,000.

Based on our interpretation there would be an annual allowance charge of £30,000 to be paid by the client. This assumes that the pension input period ends in the 2007/08 and has been calculated as follows:

Closing Value…………………………..……£800,000
Opening Value (£50,000 x 10) …………….£500,000
Annual Allowance Value……………..…..…£300,000
Deduct 2007/08 Annual Allowance…...…..£225,000
Tax at 40% on….……………....…………… £ 75,000 = £30,000

Based on the Revenue's interpretation there would be no liability, nor would any of the annual allowance have been used as there is an adjustment to the opening value for deferred members of final salary schemes i.e. the opening value is increased by the greater of 5%pa, or RPI.

The above example highlights the differences between the interpretations. Our interpretation of the 2004 Finance Act is in agreement with the Revenue's own interpretation in the current version of the Registered Pension Schemes Manual at page RPSM06103050. Whilst the Revenue's change in interpretation is to be welcomed, what is a concern is the fact that in the Newsletter the Revenue state that they are going to amend the Manual, but make no mention of amending the legislation. Let's hope that there is no future change in the Revenue's interpretation.

Fraser Grant - June 2006