Employers looking to rationalise and simplify their pension arrangements may now be able to do so in relation to historic FURBS arrangements in a manner which reduces or has no disadvantageous consequences for the employee
Prior to 6th April 2006 (A-Day), many employers operated Funded Unapproved Retirement Benefit Schemes (FURBS) for the benefit of key employees. The principal reason was that under the FURBS framework, employers were able to provide deferred compensation to their higher paid employees who were subject to the earnings cap under their approved occupational pension schemes.
Currently, many employers are considering dealing with executive pension arrangements in the aftermath of the Finance Act 2004 (FA 2004). During the course of 2007, the time and resources of employers and trustees alike were absorbed by considering the effect of the FA 2004 on their main schemes and with issues such as age discrimination which came into effect in December 2006. Now, as the end of the tax year approaches, many are turning their attention to winding up FURBS.
Historic Advantages of FURBS – Pre-A-Day
Prior to A-Day, employer contributions were allowable against corporation tax at the point they were made. Although benefits paid as pension were taxed as income, there was generally no liability to tax for the employee where benefits were paid in lump sum cash form. In addition, where death benefits were paid under a discretionary trust, there was no liability to inheritance tax. The downside was that generally the employee had to have retired in order to receive the benefits.
The Effect of the Finance Act 2004
From A-Day, all FURBS automatically became Employer Financed Retirement Benefit Schemes (EFRBS) and subject to the provisions of the FA 2004. The FA 2004 materially changed the tax framework under which these “top-up” arrangements operated.
Under FA 2004, employer contributions to an EFRBS do not attract corporation tax relief until the benefits are actually paid to the member. Employees will continue to be taxed on employer contributions as benefits in kind, and they will be taxed on both lump sum cash payments as well as benefits paid as income.
Although pre-A-Day FURBS were an attractive form of providing “top-up” benefits to employees whose earnings exceeded the earnings cap, post-A-Day they have become considerably less so. “Top-up” contributions might more effectively be made to the member’s registered occupational or personal pension scheme. Employers would benefit from immediate tax relief on their contributions, and employees will at least be able to take some tax free cash benefit from the registered scheme in the future (although care must be taken to ensure neither the annual or lifetime allowances are exceeded). Alternatively, a salary supplement may be a preferable means of compensating the employee.
Many employers ceased contributions to their FURBS arrangements on or shortly after A-Day. However, while a FURBS remains as a company pension scheme, it will continue to absorb administrative and management resources and incur advisory fees.
There are some transitional protections under the FA 2004 for FURBS benefits built up prior to A-Day. The principal protection is that a lump sum received from a pre-A-Day FURBS after A-Day is not chargeable to tax if the employer has not made contributions on or after A-Day, and the employee was taxed on the pre-A-Day employer contributions.
Where employer contributions have been made both pre-and post-A-Day, then so long as the employee has already been taxed on these contributions, the cash lump sum benefit arising from pre-A-Day contributions (increased in line with RPI) will still be payable tax free.
Potential Options Available to Employers
The circumstances under which benefits from an EFRBS may be paid are broadly similar to those under which FURBS benefits could have been paid pre-A-Day, for example on retirement, in anticipation of retirement or on death. This was subject to the proviso that, prior to A-Day, FURBS benefits could not generally be paid whilst the employee remained in service with the employer. However, where a pre-A-Day FURBS is now being wound-up, this “service” restriction has now been relaxed. Additionally, no minimum age requirement applies as a condition of receipt of benefits where a pre-A-Day FURBS is being wound-up.
Potential Option 1: Winding-Up FURBS Where No Employer Contributions Have Been Made Since A-Day
HM Revenue & Customs (HMRC) has confirmed that, following a decision to wind-up a pre-A-Day FURBS where a relevant benefit is provided in substitution for a payment that would have been made on or after retirement, the benefit will ordinarily be treated as paid “in anticipation of retirement”. There is no age limit applicable to “in anticipation of retirement”. Since all the FURBS benefits relate to pre-A-Day service, they may be paid out tax free in lump sum cash form, providing the employee has paid tax on the employer contributions.
Potential Option 2: Winding-Up FURBS Where Employer Contributions Have Been Made Both Pre- and Post-A-Day
If a pre-A-Day FURBS to which employer contributions have been made post-A-Day is to be wound up, a cash lump sum can be paid tax free in respect of the pre-A-Day employer contributions (increased from A-Day by RPI). The post-A-Day balance of the cash lump sum will be taxable as employment income.
Implication for Employers
Employers looking to rationalise and simplify their pension arrangements may now be able to do so in relation to historic FURBS arrangements in a manner which reduces or has no disadvantageous consequences for the employee.