HMRC has announced that cash inducements will now be taxable as employment income under section 394 of the Income Tax (Earnings and Pensions) Act 2003. Such payments will also be subject to class 1 National Insurance Contributions. However, enhancements to transfer values will continue to be treated as normal employer pension contributions.

Previously, HMRC had varied the taxation treatment of individual cash inducements depending on the facts of each individual case. HMRC’s guidance provides the following exemptions for transactions entered into before 24 January 2007 (the date of its announcement):

  • payments made before 24 January 2007 which were not treated as taxable under the “former view of the law”;
  • where an employer made an offer to members before 24 January 2007 but payments have yet to be made and HMRC had previously confirmed that the payments were not taxable (subject to there being no material changes to the original offer); and
  • where an employer has made an offer to members before 24 January 2007 and can show that it relied on HMRC’s former view of the law.

The second two exemptions only apply to the extent that the payments would not have been taxable under HMRC’s former view of the law.

Although the new approach adopted by HMRC offers welcome clarity, it may be open to challenge. Rather than a new charging provision, the announcement is an interpretation of existing law. A Technical Note issued by HMRC on 9 February 2007 sets out in more detail why HMRC believe that cash inducement payments are subject to Income Tax and NICS. According to HMRC a cash inducement payment is taxable on the basis that it is paid “in anticipation of the retirement of an employee or former employee”. However, this reasoning appears to be flawed as it is unclear how this provision could apply to a cash inducement payment made to a deferred member of a scheme who has never been employed by the company offering the inducement. However, HMRC’s interpretation of the law is unlikely to be challenged in the courts by employers, who are most likely to switch to offering enhanced transfer values instead.

Conclusion

The Government’s proposals for the calculation of transfer values and the firm guidance on making inducement offers may encourage more employers to seek to reduce their financial and regulatory burden by proposing incentives to members to transfer their benefits out of final salary schemes or to accept rule changes. However, the removal of favourable tax treatment for cash incentives will reduce the appeal of this type of inducement and inducement offers, going forward, are perhaps more likely to be in the form of enhanced transfer values.

There has been speculation in the press recently that the DWP intend to clamp down further on the practice of offering cash inducements by introducing additional disclosure requirements. We will keep you updated on any further developments in this area.