The Government wants to end the current mismatch between tax relief claimed by employers and contributions received by pension schemes.
Since Marks and Spencer pioneered the principle in 2007, employers have made roughly £4 billion of asset-backed contributions (ABC) to their pension schemes.
The principle is simple: the sponsoring employer uses its income-producing business assets, for example property, to generate a revenue stream payable to its pension scheme. The advantages to the employer include:
- Immediate tax relief on the value of the asset and on subsequent income stream.
- No impact on the employer's balance sheet.
- The ability to spread deficit payments over several years.
- Retention of day-to-day control of the assets.
In return, schemes obtain:
- An immediate deficit reduction.
- A secure income stream.
- The added security of a right to the underlying asset in certain circumstances, for example employer insolvency.
In practice, high set up costs means that only the larger pension schemes tend to use ABC structures.
Current Issues – Why the Proposed Change?
- To address the mismatch between tax and accounting rules.
- To prevent employers obtaining excess relief.
The Government became aware of employers with ABC arrangements receiving greater tax relief than the fair value of assets received by the pension scheme. Although ABC arrangements take a number of forms, generally the installments (typically rental payments) would contain some form of contingency, e.g. they would be dependent on the level of dividends by the employer. Because of the contingent element, the arrangements would be accounted for in the employer's accounts as equity under FRS 25/IAS 32 and would not fall within the scope of the structured finance arrangement anti-avoidance rules contained in the Corporation Tax Act 2010. Therefore an employer could receive tax relief twice, initially in respect of the value of the asset and subsequently for each installment of the income stream.
Please refer to this example as a typical structure.
Recognizing the flexibility that ABC structures provide, the Government does not intend to prohibit their use. However, it has clearly signaled its preference to align tax and accounting rules and proposed two options for consideration:
- No upfront tax relief
Under this option tax relief would be available only when the trustees receive cash from the ABC or get full title to an asset which they can convert into cash.
This would affect ABC structures where trustees cannot sell the right to an income stream and would make the above example unattractive.
- Tax relief reflects the “economic substance” of the transaction
This option, which is the Government’s preferred choice, would align tax and accounting rules for the life of the ABC. It would prevent double tax relief and allow HMRC to claw back excess relief. Upfront tax relief would still be available where company accounts show an ABC as debt rather than equity. Hence in the above example, assuming that it could be structured as a debt, there would still be an upfront tax deduction for £400m, being value of the asset being made available, and further relief on the balance of the income stream of £50m over 20 years.
ABC offers commercial flexibility and a viable method of deficit reduction. Employers will not welcome an end to the previous tax relief. However ABCs still offer an attractive proposition in the right circumstances.
In practice, high set-up costs mean that only the larger pension schemes tend to use ABC structures.