The Treasury today (July 21) published a 40-page call for evidence which presents the options being considered to address the difference in outcomes between net pay and relief at source pension schemes, as announced at the March Budget.
Members of relief-at-source pension schemes, who don't pay income tax, are granted basic rate tax relief of 20 per cent on pension contributions up to £2,880 a year. In practice this means HMRC will top up a net contribution of £2,880 to a gross £3,600.
But these schemes are only accessible through a handful of companies. The more common net pay schemes do not offer access to such tax relief.
To align the tax treatment for those contributing to pension schemes with the same incomes but using different methods of tax relief, the government is exploring four methods.
Method 1 - HMRC bonus
The first method involves HM Revenue and Customs (HMRC) paying a bonus to lower earners who are in net pay schemes to put them in the same position as lower earners who are members of relief at source schemes.
Under this proposal HMRC would use the current end of year process to identify those who contribute to a net pay pension scheme and have total income below the personal allowance.
The tax authority would then provide them with a payment equal to the basic rate of tax on their contributions.
But the government said it is “unlikely to proceed with this proposal” as it introduces additional complexity for members, pensions schemes and HMRC and there would also be a sizeable time lag between the pension contributions being made and the bonus received.
It would also require costly administrative changes.
Method 2 - standalone charge
Another proposal was for HMRC to apply a standalone charge to recover the top-up given under the relief at source method.
This would see individuals subject to a stand-alone tax charge or the amount could be reclaimed from the pension scheme.
The government is also against this proposal as it would mean taking money from some of those on lower incomes who are saving for their retirement.
It would increase administrative burdens on employers and relief at source scheme administrators.
The paper stated: “Further, it would not, by itself, equalise outcomes as a [relief at source] saver would still have a lower personal allowance than a member of a net pay scheme.”
Method 3 - multiple schemes
A third option explored by the Treasury is that employers could be made to provide two schemes for their employees, one net pay and one relief at source.
Employers would switch employee contributions between schemes depending on whether their earnings would take them over the personal allowance for that pay period or not.
While the government is not keen to make this approach mandatory it said employers could voluntarily adopt a similar approach.
It warned the approach required close working relationships between the employer and their payroll and pension providers to set up the necessary systems to automate the “switching” process.
But it has also been suggested that once the initial implementation has been completed the burden would be manageable.
It stated: “The government would welcome evidence relating to the costs of this approach (including pension scheme operator fees and payroll costs) to assist in its evaluation.”
Method 4 - mandate relief at source
A more radical approach would be to require all defined contribution schemes to operate on a relief at source basis.
Different versions of this proposal include requiring all employers with low-earning employees to use relief at source DC pension schemes, all new DC schemes to use relief at source (and removing the option to apply to operate net pay) or for all DC schemes to move to relief at source arrangements.
The government said this method was attractive for introducing a single method of tax relief for some or all DC savers.
It stated: “The government recognises that there would be many changes required to scheme and payroll processes.
“There may also be a need for employers to review employment contracts to fully understand the impacts for their employees.
“Evidence on the changes required, and steps that government could take to mitigate any negative effects would be welcomed.”
The executive summary stated: “To date a proportionate and straightforward solution to address the difference in treatment for low earning pension savers has not been found. There is a balance to be struck between ensuring consistency in outcomes and ensuring simplicity for individuals.
“The options considered in this call for evidence all have drawbacks and would introduce significant complexity into the pensions tax regime for employers and pension schemes.
“Any changes would be difficult to explain to individuals and are likely to lead to greater engagement with HMRC by individuals who would otherwise have no need to contact them.”
The call for evidence closes to responses on October 13, 2020.
amy.austin@ft.com
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