Jonathan Sharp and Alasdair Friend, Baker & McKenzie, consider the legal issues for employers of the forthcoming restrictions on pension savings for high earners.
In a nutshell:
- while many employers will tell employees about pension tax changes as part of good employee relations, it is unlikely employers have a legal obligation to issue such communications
there are a number of options for employers to offer to employees affected by the tax charges, such as paying cash or using employer financed retirement benefit schemes (EFRBS)
employers should check alternative benefit options do not breach age discrimination legislation or anti-avoidance measures, or trigger pensions consultation requirements.
The impact of the 6 April 2016 tax changes on high earners has been widely reported, but what are the legal issues that employers need to be thinking about in relation to the changes?
Communication to members
A distinction must be made between what employers may do as part of best practice, and whether there is a minimum legal obligation that employers need to meet in communicating with employees.
As regards any minimum obligation, case law suggests that there is no obligation on employers to notify employees of tax changes, and that the obligations on an employer do not extend to effectively being an employee’s “financial adviser”(University of Nottingham v Eyett). It would be a very high burden to put on employers if such a positive obligation applied.
This approach has been supported by the Deputy Ombudsman in a 2014 determination (Ramsey PO-3290). In that case, a member complained against the trustees, company and administrators for not notifying him of the tax charges arising from a reduction in the annual allowance (AA), when he took his benefits a few months after 6 April 2011. The Deputy Ombudsman held that none of these parties had a legal obligation to bring the AA reduction to the member’s attention.
The Deputy Ombudsman noted that the trustee communications referred to the member taking independent financial advice, and that this showed the trustee was not giving such advice. Companies and trustees should therefore ensure that communications they issue point the member towards seeking financial advice, so that it is clear to the member that neither the employer nor trustees are themselves providing such advice.
It is worth comparing the Ramsey determination against the recent Cherry determination (22 December 2015, PO-7096). Mr Cherry was a police officer who started receiving his pension before age 55, but due to re-employment by the police within one month of retiring, he no longer met the requirements for a protected pension age. This meant the pension payments before age 55 were unauthorised payments.
While agreeing that there was no legal obligation on the employer to advise employees on their tax and pension liabilities, the Ombudsman went on to state that the police commissioner “as a responsible employer” had an obligation to inform Mr Cherry of the tax consequences of re-employment. Although the Ombudsman did not specify the reasons for the difference between Ramsey and Cherry, the distinction may be between general financial advice and the very specific tax implications of re-employment in this case. Another distinction could be that the protected pension age requirements are obscure and unlikely to be known by retirees, whereas there is a greater general awareness of the AA and LTA changes.
If employers or trustees are issuing communications to members concerning tax changes then they should ensure that the communications are accurate. While there may be no legal obligation to issue such communications, if incorrect communications are issued then potentially a member could bring a maladministration complaint.
Benefit design options
There are two aspects to benefit design changes. The first concerns the reduction (or stopping) of the benefits being built up under the pension scheme, and the second is what alternative benefit will be provided instead.
In relation to the former and limiting benefit accrual, the options are similar to those that employers would consider when looking to make pension savings generally. For example, options could include members opting out of benefit accrual, capping pensionable salary, and altering accrual rates (defined benefit (DB) schemes) or reducing contribution rates (defined contribution (DC) schemes).
As regards the second aspect, the most obvious and simple way of increasing the value delivered to employees, as an alternative to accruing pension benefits within a pension plan, is to increase the amount of cash paid to them. The downside with this is that it would be very difficult to control what the employees did with the money; rather than being a substitute for pension contributions, this could simply be seen as additional salary. Also, any such payments would be subject to income tax and national insurance contributions (both employer and employee) on payment. There are, though, some non-pension tax efficient investment vehicles in which the employees could invest this money and be able to recover some of the tax paid. For example, an individual can invest up to GBP200,000 per tax year in a venture capital trust and obtain 30 percent income tax relief on the investment; capital gains made on the investment are free of capital gains tax provided certain conditions are satisfied.
Alternatively, companies could offer their employees additional pension payments outside of the registered pension regime. Such non-approved pension arrangements are known as “employer financed retirement benefits” (EFRBs). These arrangements can be either funded or unfunded. Unfunded arrangements are, in essence, simply promises to pay at a future date. The ability of the employer to make such payments depends entirely upon the employer’s financial position as and when such payments become due, or indeed upon the continued existence of the employer for what might be a significant period of time. Unfunded arrangements are therefore less likely to be attractive to employees.
There might, therefore, be advantages in making financial provision for such payments. This, though, creates the danger that the arrangements could fall within the scope of the “disguised remuneration” legislation. If this applied, tax could be due when funds were initially allocated to hedge the arrangements. Broadly speaking, the disguised remuneration legislation applies when cash or assets are held on trust and “earmarked” for specific employees, pending payment to them.
If the arrangements in which cash or other assets are held to hedge the future liabilities constitute a trust arrangement, the disguised remuneration legislation would be likely to apply. The most obvious application of the legislation is where assets are transferred to an external trustee to hold, but the regime can also apply where a company itself holds assets on trust for employees. In contrast, if assets are designated and held by a company in an account that is not on trust, so that they could be subject to claims by the company’s creditors, the disguised remuneration regime should not kick in.
60 day pension consultation requirements? Provided that alternative benefits are at the election of the employee, so that members have the option of continuing their existing benefit accrual, there is a good argument that the pension consultation requirements would not apply.
Age discrimination issues? Age discrimination issues could arise in the context of alternative benefit proposals. An employer may only wish to offer alternative benefit options to employees above particular grades (indirect age discrimination, if they are generally older?). However, such a claim could be defended on the basis that employees must show they have been treated worse than another employee whose position is the same or not materially different (a comparator). This would generally prevent junior employees from claiming by comparing themselves with more senior employees. Alternative types of age discrimination may need to be “objectively justified”, for example, on the grounds that they encourage the retention of staff.
Anti-avoidance The government has introduced anti-avoidance measures that apply where someone intends to circumvent the AA changes. Broadly, the key feature to be noted when designing benefit options is that the anti-avoidance measures apply where a reduction in income for one tax year is redressed by an increase in income another tax year.