Following the Lloyds judgement in 2018, where the High Court ruled that pension schemes must equalise benefits to account for historic sex discrimination in the calculation of GMP, GMP equalisation has become one of the biggest challenges for formerly contracted-out defined benefit pension schemes and almost four years on from the judgement continues to be a hot topic in the industry.

A particular aspect of GMP equalisation that has caused longstanding confusion is the tax implications of GMP conversion, which is one method by which trustees and employers may carry out GMP equalisation. GMP conversion exercises may lead to members breaching annual and lifetime allowance limits under tax legislation, and many stakeholders have been calling for some time for HMRC to issue guidance clarifying the circumstances in which this will occur.

Responding to these calls, on 6 April 2022 HMRC issued a GMP equalisation newsletter supplementing its earlier guidance on lump sums and annual and lifetime allowances, covered in blogs in February and July 2020. The Guidance aims to provide some clarification on the issues of both tax implications of GMP conversion and transfer top-up payments.

Transfer top-up payments

The first area covered by the newsletter is top up payments to past transfers, which are made where a previous transfer payment was not adjusted to remove the inequalities caused by GMPs.

The Guidance confirms that a top-up transfer payment will generally be an authorised payment provided it meets the various elements of a recognised transfer at the time the payment is made. In respect of the receiving scheme, it must be a registered pension scheme or qualifying recognised overseas pension scheme at the time the top-up transfer payment is made. This may be the same scheme to which the original transfer payment was made, or it may be a different scheme.

Lump Sum payments

The Guidance also confirms that lump sum payments directly to a member to effect GMP equalisation may also be possible where it meets the payment condition at the time the payment is made.

There are various types of lump sum payments that can be made, and some of these can also be paid to another individual where a member has died. These include a lump sum payment following a "relevant accretion" and a small, one-off lump sum payment – both under conditions contained in the Registered Pension Schemes (Authorised Payments) Regulations 2009, and both up to a limit of £10,000.

In the case of relevant accretion, the transfer must have taken place prior to 6 April 2006, the scheme administrator must not have been aware, at the time of the original transfer, that the member was entitled to a benefit under the transferring scheme and the payment must be made no later than 6 months after the date the accretion occurs. The six-month period begins when the scheme administrator establishes the member's entitlement to a transfer top-up and the amount of this.

Small lump sum payments are not available where there's been a recognised transfer in respect of the member in the 3 year period preceding the payment.

A winding-up lump sum payment up to a limit of £18,000 may also be paid where the pension scheme is winding up and the conditions for this payment are met.

Taxation

The Guidance confirms that the right to a top-up transfer payment and any lump sum paid to extinguish that right is an uncrystallised right for tax purposes. Where payment is to the member or their estate, 75% of a lump sum will be taxable, but if this is paid to another person following the member's death tax will be payable on the whole sum. In terms of the annual allowance, the Guidance confirms that no further implications arise where the scheme administrators pay a top-up payment or lump sum directly to the member to extinguish that right.

The Guidance also confirms that certain transitional protections will continue to apply after a transfer where this meets the conditions for a 'block transfer'. However, paying additional transfers where these are not permitted transfers could result in the loss of fixed or enhanced protection.

GMP conversion

In their newsletter, HMRC confirm that they continue to look at the effects and tax implications associated with the complex area of GMP conversion with an industry working group but seek to give guidance where they can on aspects of the pensions tax legislation.

Deferred Members

In respect of deferred members, HMRC note that "there are likely to be impacts on the treatment of their annual allowance in the tax year of conversion, as well as in all subsequent tax years up to and including that of retirement". This could include the loss of a member's deferred member carve-out and lead to a pension input amount calculation for that tax year and subsequent tax years. GMP conversion may also lead to the loss of fixed protection for deferred members as fixed protection is lost where, at any time in a tax year, a member's benefits increase more than a certain amount.

HMRC says schemes wishing to use the conversion method should consider the tax implications that may arise for deferred members in accordance with existing legislation and that further work is needed in this area to definitively determine the outcome and treatment, and whether any legislative change may be needed.

Pensioners

Guidance is also given on the tax position for pensioner members. The conversion of their benefits would not amount to benefit accrual for the purposes of the annual allowance, meaning there is no pension input amount, and conversion will also not impact fixed protection as long as all benefits in the arrangement have been crystallised. However, it could potentially amount to a benefit crystallisation event for the purposes of the lifetime allowance.

For recently retired pensioners in respect of whom conversion occurs in the tax year of retirement, conversion still does not constitute benefit accrual for annual allowance purposes, nor does it impact whether the deferred member carve-out will apply to the member in that tax year. In respect of the lifetime allowance, in assessing whether conversion triggers a benefit crystallisation event this will be tested against the level of pension in payment before conversion, and on which the member's retirement benefit crystallisation events would have been assessed if equalisation is implemented post-retirement.

Members who left service prior to 5 April 2006

Finally, for members who left pensionable service prior to 5 April 2006 and have remained outside annual allowance provisions since then, they should still remain outside those provisions as long as the new benefit has the same actuarial value following conversion.

Further guidance from HMRC's working group on tax challenges

Whilst much of the guidance from HMRC is useful and answers questions that have pervaded the industry for some time, there are still areas where further clarity is needed. HMRC's own working group on tax challenges has acknowledged the uncertainty around some issues, including the tax treatment of the interest element, and has sought to give some further detail on this via a statement from the Pensions and Lifetime Savings Association (PLSA).

The statement both confirms that another newsletter from HMRC is anticipated in the near future to provide further explanation and gives details of the general principles shared by HMRC with industry members of the GMP equalisation working group. This included confirmation that for GMP equalisation and pensions tax purposes, the interest payment is to be treated as being made in respect of a late payment of pension instalments. Further, interest was likely to be 'yearly interest' for tax purposes and it is not likely that an obligation to withhold income tax would arise under section 874 of the Income Tax Act 2007 (unless the payment falls to a person whose usual place of abode is not in the UK). Finally, the statement confirmed the interest element should be covered by the personal savings allowance.

Other recent developments

The Guaranteed Minimum Pension (GMP) Equalisation Working Group (GMPEWG), chaired by the Pensions Administration Standards Association (PASA), recently published a Q&A of questions frequently raised during the equalisation process.

The document is designed to provide pragmatic guidance on good practice for administrators implementing GMP equalisation. The guidance includes answers, based on the collective view of the GMP Equalisation Administration sub-group, to a range of frequently asked questions (FAQs) on the equalisation process and will be updated and added to over time as GMP equalisation projects progress and different approaches and solutions emerge.

On 28 April 2022, the Pension Schemes (Conversion of Guaranteed Minimum Pensions) Act 2022 received Royal Assent. The provisions of the Act, which was introduced as a Private Members' Bill with the backing of the DWP, will be brought fully into force by regulations made by the Secretary of State for Work and Pensions. Once implemented, the Act will modify the existing conversion legislation to clarify and simplify the employer consent requirements and confirm the level of minimum survivor pension which must be provided post-conversion. It will also remove the requirement to notify HMRC of the members whose benefits are being converted. It is hoped that the changes introduced by the Act will make the GMP Conversion process easier for trustees to navigate.

Conclusions

Whilst HMRC's further guidance is welcome and helpful in clarifying some of the uncertainties as regards the unintended tax implications arsing in respect of transfer value top-ups, many of the concerns in relation to GMP conversion, particularly in respect of deferred members, remain. Although it is a step in the right direction that HMRC have confirmed their continued intention to work through GMP conversion tax issues and decide if any potential legislative change is required, as well as to issue further guidance in the near future, detailed scheme specific advice will still be required for schemes seeking to move forward with GMP conversion exercises until an appropriate outcome is determined.