Using unfunded pension arrangements tax efficiently

The changes to the tax efficient pensions regime made by the Finance Act 2011 included making reductions to both the Annual and Lifetime Allowances. Coupled with this, new provisions were introduced to limit the opportunity for using employer financed retirement benefit schemes ("EFRBS") as a means of sidestepping these limits. However, these new "Disguised Remuneration provisions" do not catch all types of EFRBS: this briefing looks at the possibility of using secured EFRBS arrangements within the new regime. In addition to implementing reductions to the Annual and Lifetime Allowances, the Finance Act 2011 introduced provisions which are designed to limit the opportunities available to employers and employees to use unregistered EFRBS to sidestep the impact of these reductions. In summary, these Disguised Remuneration provisions operate by causing immediate tax charges to arise on the accrual of pension benefits in many EFRBS structures. The main target of the Disguised Remuneration regime seems to be funded arrangements. Contributions to a funded EFRBS arrangement will now be immediately taxable in the hands of the employee. It appears from HMRC's guidance that the one exception to this will be where contributions are made to an arrangement on a "pooled" basis, such that they cannot be attributed to a single member. However, whilst this means that defined benefit arrangements where there are multiple members are likely to be feasible, immediate tax charges will nevertheless arise under single member and defined contribution arrangements. Whilst funded arrangements may now be less popular, HMRC has confirmed that wholly unfunded EFRBS will fall outside the new regime. Such arrangements may therefore offer an alternative structure for employers wishing to compensate employees for the loss of accrual in their registered pension schemes (or for the tax charge applying to such accrual). From the employee's perspective, of course, the drawback of an unfunded arrangement is the absence of any security for the benefit promise in the event of employer insolvency. To mitigate this risk, the employer could provide security in respect of the unfunded promise. Whilst some commentators have taken the view that secured unfunded arrangements will also fall foul of the Disguised Remuneration provisions, in our view this need not be the case. HMRC has stated that: * the Disguised Remuneration provisions will not apply providing there is a promise for the employer to pay benefits to the employee directly (i.e. without the involvement of a third party trustee); * providing security will not affect this analysis, provided that the terms on which the security is held by the security trustee do not permit realisation of the security unless and until a specified event occurs as a result of which there ceases to be a realistic prospect of the benefits being paid by the employer; and * the security is provided on a "pooled" basis, i.e. so that it is not attributable to a particular individual. These clarifications are now reflected in the HMRC Disguised Remuneration guidance. Although HMRC has indicated during consultation that it will continue to monitor events and consider amendments to the Disguised Remuneration regime if it found evidence of abuse, it is clear that its present view is that secured unfunded EFRBS do not constitute such abuse. Consequently, as a response to the reduced annual and lifetime allowance regimes a secured EFRBS may be an attractive alternative to cash compensation: they can be used to replace "like with like", do not give rise to any up front tax charge and no additional NICs liability should be incurred.