Pensions and Employment: Pensions Bulletin

Transcription

1 slaughter and may Pensions and Employment: Pensions Bulletin ISSUE 10/09 Legal and regulatory developments in pensions In this issue New Law Restricting pensions tax relief: Where are we now? Pensions Regulator Record keeping: measuring member data: guidance updated Statement on employer covenant Independent Trustee Register review: consultation response Winding-up: Avoiding delays: guidance updated...more...more...more...more...more Points in Practice Repayments of surplus: action required Interest on late payments of pension: a reminder to trustees PPF levy deadlines: a reminder Miscellaneous Actuarial organisations to merge...more...more...more...more To access our Employment/Employee Benefits Bulletin click here. Contents include: Cases round-up UK Corporate Governance Code updated Data protection: export of personal data to processors outside the UK BIS proposals for reduction of excessive regulation. Back issues can be accessed by clicking here. To search them by keyword, click on the search button to the left. Find out more about our pensions and employment practice by clicking here. For details of our work in the pensions and employment field click here. For more information, or if you have a query in relation to any of the above items, please contact the person with whom you normally deal at Slaughter and May or Rebecca Hardy. To unsubscribe click here.

2 New law Restricting Pensions Tax Relief: Where are we now? There has been no word one way or the other from the new Coalition Government on the future of the 2011 restrictions on pensions tax relief for high income individuals. The Government may confirm its position in the emergency budget on Tuesday, 22nd June, The focus accompanying this issue of the Pensions Bulletin summarises the current position for the new high income excess relief tax charge on pension savings legislated for in the Finance Act Pensions regulator Record keeping: measuring member data Trust law requires that trustees keep clear and accurate accounts of trust property. Additional duties relating to record keeping stem from pension scheme trustees statutory duty 1 to establish and operate adequate internal controls. Specific statutory record keeping requirements are also in Section 49 of the Pensions Act 1995 (relating to receipts, payments and records) and in the Scheme Administration 2 and Disclosure Regulations 3. Anyone involved in a buy-out, buy-in or longevity swap transaction will appreciate the difficulties, and additional cost, caused by inaccurate scheme data. The Regulator is now focusing on minimising the risks associated with poor record keeping. It published revised guidance on the subject on 2nd June, The revised guidance follows publication of a consultation paper on 2nd February, 2010, triggered 1 In Section 249A of the Pensions Act The Occupational Pension Schemes (Scheme Administration) Regulations The Occupational Pension Schemes (Disclosure of Information) Regulations by research by the Regulator showing that take up of its existing record keeping guidance was low. The revised guidance sets out a strengthened approach that includes: an expectation that all schemes measure their scheme data, recommending specific targets for standards of common data. Common data are data applicable to all members of all schemes, and include NI numbers, names, addresses, dates of birth and membership status, recommending a scheme specific approach for conditional data, with schemes setting their own targets, which should be challenging but realistic. Conditional data are dependent on the type of scheme and a member s status in the scheme. Examples for a DC scheme include investment split and details of investment units bought and sold, recommending that numerical information be made available to trustees to supplement basic scheme membership numbers, S L A U G H T E R A N D M AY 2

3 using regulatory powers to investigate standards within schemes including sampling schemes for data audit, potential enforcement action where there is a breach of the legislative requirements referred to above, setting a deadline of December, 2012 for the resolution of outstanding data issues, and enhancing the educational material, such as the trustee toolkit, on the Regulator s website. The targets for accuracy remain as set out in the February consultation and are as follows: New data (created from June, 2010 onwards) Common Conditional 100% Scheme specific Legacy data 95% Scheme specific According to the consultation response, published alongside the revised guidance, the targets will be triggers which the Regulator will use to help in its risk assessment when considering whether to investigate the matter further, or take some other regulatory action. It will not always take action against schemes which fail to make the required targets. The Regulator proposes that a small set of common data fields and a limited number of conditional data fields be checked for accuracy by schemes. It believes that most computer system providers will be able to provide systems to perform such data checks, and to produce reports. Where data is not held on computer systems, administrators, trustees and employers should consider whether this is the best way of holding records. The Regulator says it will only escalate to enforcement action against a scheme where there is reliable evidence of it breaching a legal obligation set out in the primary or secondary legislation referred to above and which the Regulator has the legal power to enforce. Where a scheme is in breach of its legal obligations and does not meet the required targets for common data, the Regulator will expect to see evidence that: the condition of scheme records has been measured, there is a concrete plan to meet the targets by the end of 2012, and the plan demonstrates that reasonable endeavours to resolve inaccurate or missing data are being taken. The timescale for achieving the targets remains the end of Where the targets are not met, the Regulator will consider any explanatory evidence put to it on a case by case basis before taking enforcement action. The Regulator is in continuing dialogue with the auditing profession on whether auditors should report data issues in their annual scheme audit. Currently, auditors believe that much of the data testing set out in the Regulator s guidance goes beyond the scope of the statutory audit. However, weaknesses identified in the quality of member data would be communicated by auditors to their clients as part of the management reporting process. The Regulator states we will hold trustees accountable for poor member data; they in turn will want to consider what role their auditors should play in meeting this accountability. The Regulator will continue to monitor progress and will report again in S L A U G H T E R A N D M AY 3

4 The revised guidance and consultation response are available on the Pensions Regulator s website. Action point: This is important. Record keeping deficiencies will be picked up on, even if your scheme is not selected by the Regulator for a spot check. Inaccurate scheme data causes difficulties for schemes negotiating buy-out or buy-in arrangements, or longevity swaps, and may affect the pricing of such arrangements. You need to read the new guidance and prepare an action plan for achieving the Regulator s targets in the 18 months available. Step 1: Identify the set of common and conditional data fields to be checked and the process for checking. Step 2: Draw up a timetable for implementing the checks. Step 3: Analyse the results and, if necessary, establish a process for remedying defects. Step 4: Implement the remedial process and check the results. Statement on employer covenant On 9th June, 2010, the Pensions Regulator published a statement for trustees of DB schemes detailing upcoming guidance and e-learning on the employer covenant. The statement also sets out the Regulator s expectation of trustees in relation to employer covenant issues, building on its June 2009 focus on the subject. Points to note include the Regulator s expectation that: all trustees should have a framework for assessing and reviewing the employer covenant, including monitoring, trustees of multiemployer schemes need a good understanding of the employer covenant and the liabilities of employers and other guarantors so that they can quickly and confidently decide whether to approve an arrangement to enable employers to restructure or withdraw from the scheme, trustees and employers should prepare plans for realising the employer s support standing behind a scheme (for example contingent assets, or negative pledges) should this become necessary, trustees and employers will act proportionately in approaching covenant assessment and monitoring. The Regulator recognises that it may not be affordable or appropriate for all schemes to put in place elaborate contingent asset arrangements but other arrangements such as positive and negative pledges and sharing in anticipated increases in cash flow can be considered. The Regulator is to publish a series of new guidance documents for consultation in the coming weeks: guidance on monitoring employer support, providing more information on what trustees should do to measure and monitor the employer covenant and outlining action trustees should take to strengthen the scheme s security if needed as a consequence of these assessments. The guidance will advise on how contingent assets and other arrangements can work alongside the employer covenant to provide further safeguards, guidance for trustees of multiemployer schemes, explaining the importance of understanding who is legally responsible for supporting the liabilities in a multiemployer scheme, assessing the strength of the covenant supporting the scheme, and the options for mitigating the risk associated with the departure of an employer from the scheme. The guidance will cover all the mechanisms which may apply when an employer departs from a multiemployer scheme, and S L A U G H T E R A N D M AY 4

5 revised guidance on transfer incentives and other situations in which members are asked to consider substituting or converting their benefits. This is to replace the current inducements guidance and will set out a principles-based approach to the issue. All these publications are to be supported by bite sized e-learning tools to help trustees. The statement is available on the Pensions Regulator s website. Independent Trustee Register review: consultation response On 26th May, 2010, the Pensions Regulator published its response to its December, 2009 consultation on the proposed new criteria it intends to apply when assessing who may join and remain on its register of independent trustees. Regulations 4 require the Pensions Regulator to compile and maintain a register of independent trustees that satisfy certain conditions. The register is used by the Regulator to appoint independent trustees to schemes, usually on appointment of an 4 The Occupational Pension Schemes (Independent Trustee) Regulations 2005 insolvency practitioner in relation to the scheme s employer. There are currently 51 trustees on the register, comprising both individuals and corporate trustee firms. The consultation proposed changes to how the Regulator assesses whether applicants satisfy the legislative conditions. The Regulator will now be releasing a new trustee register section on its website to include: guidance on how it will assess applicants, and the new application form. The Regulator will be contacting those trustees currently on the trustee register to invite them to resubmit their application in the new format by 31st July, All applications, including for those trustees currently on the register, will be assessed against the new criteria. The consultation response is available from the Pensions Regulator s website. Action point: For noting, unless you are, or aim to be, an independent trustee listed on the register. Winding-up: avoiding delays: guidance updated On 2nd June, 2010, the Regulator published on its website an updated version of its winding-up guidance. The Regulator published a consultation paper proposing revisions in February The consultation report that accompanied publication of the revised guidance reveals: the proposal to remove references to GMP equalisation as an acceptable reason for delay attracted a number of responses. The Regulator has stuck by its decision to remove the references, in order to avoid potential inconsistency between its guidance and the respective recent announcements of the DWP, PPF and FAS in this area, and a number of respondents suggested that the 2 year target for winding-up schemes may not be workable. The DWP deliberately did not include the 2 year deadline in the issues for consultation, remaining of the view that the deadline is reasonable. The Regulator s press release accompanying publication of the revised guidance notes that the original 2 year wind-up target set out in the version of S L A U G H T E R A N D M AY 5

6 the guidance published in June 2008 expires on 30th June, According to the Regulator, progress in achieving that target has been positive, particularly with DC schemes, and its view remains that the target is reasonable. The Regulator will be intensively scrutinising those schemes that have failed to meet the target. The revised guidance, consultation response and press release are available on the Pensions Regulator s website. Action point: If your scheme is winding up, or contemplating winding up, read the guidance. Points in practice Repayments of surplus: action required Section 251 of the Pensions Act 2004 provides that a repayment of surplus may be made to a sponsoring employer only if the scheme trustees pass a resolution to preserve such power by 6th April, Trustees may only pass such a resolution once, and then only if they: are satisfied that any resolution is in the interests of scheme members, ensure that members are given 3 months written notice of the proposed resolution, ensure that the power to pay surplus to the employer is exercisable by the trustees, and ensure that payments can only be made where the scheme is fully funded on a buy out basis. On the face of it, Section 251 applies only to schemes that have a power to repay surplus while the scheme is ongoing. However, there has been a concern that it may apply to any scheme which has a power to repay surplus on a winding up. The focus accompanying this issue of the Pensions Bulletin summarises the background to Section 251 and the action that now needs to be taken. Action point: If your scheme contains a power to repay surplus you need to consider what action to take. For further information, please contact the person you normally deal with on pensions matters at Slaughter and May. Interest on late payments of pension: a reminder to trustees Under trust law, pension scheme trustees are obliged to pay interest on pension benefits that are paid late unless the trust deed and rules provide to the contrary. This is so notwithstanding that the reason for late payment is that the trustees had not known, and had no way of knowing, that the event giving rise to the pension entitlement (for example the death of a deferred member) had occurred. This point has been confirmed to us on a number of occasions by Leading Counsel, who have advised that, in most cases, simple, as opposed to compound, interest will be payable, and at a reasonable commercial rate. S L A U G H T E R A N D M AY 6

7 Note that the position is different for contractual pension arrangements, where no interest is payable unless the contract provides otherwise. Action points: Trustees should ensure that either they pay interest on benefits paid late, or that their trust deed and rules permits them not to. For further information, please contact the person you normally deal with on pensions matters at Slaughter and May. PPF levy deadlines: a reminder Miscellaneous Actuarial organisations to merge The Actuarial Profession has announced that members of the Faculty of Actuaries in Scotland and the Institute of Actuaries in England and Wales have voted in favour of merging their organisations to form the Institute and Faculty of Actuaries /2011 levy 30th June, 2010 at 5 pm: deadline for certification of full block transfers that have taken place up to and including 31st March, Autumn, 2010: invoicing scheduled to begin. 2011/2012 levy 30th June, 2010 at 5 pm: deadline for certification of partial block transfers that have taken place up to and including 31st March, Autumn, 2010: consultation on rules for levy: levy estimate and levy scaling factor to be published. Winter, 2010: final determination and scaling factor to be published. S L A U G H T E R A N D M AY 7

8 Restricting pensions tax relief: where are we now? 1. Coalition plans the big unknown There has been no word one way or the other from the new Coalition Government on the future of the 2011 restrictions on pensions tax relief for high income individuals. We expect that the Government will confirm its position in the emergency Budget on Tuesday, 22nd June, With a forecast UK borrowing requirement of 157 billion for the current tax year, it seems highly unlikely that restrictions on pensions tax relief will be lifted. The question is whether the new Government will stick with the current approach, which is already partly legislated for, extend it or move to a different model. If the Coalition Government decides to stick with the current approach, but extend it, this could result in, for example: a reduction in the income thresholds identifying high income individuals, or the restriction of tax relief to the basic rate for all tax payers. (This was proposed in the Liberal Democrat manifesto). An alternative model (suggested at the consultation stage by bodies such as the NAPF) would be to reduce greatly the annual allowance. The annual allowance currently rations pensions tax relief on an annual basis for all tax payers, and stands at 255,000. HM Treasury have estimated that the proposed new tax charge would result in a tax yield of over 3 billion. This suggests that if the reduced annual allowance route is followed, the annual allowance might be set at around 20,000 to 30,000 per annum. Comment: This would broadly equate to the current anti-forestalling special annual allowance level 1. 1 The special annual allowance charge is the tax charge introduced as part of the anti-forestalling measures by Finance Act The tax is charged on unprotected pensions savings over the special annual allowance which is set at 20,000 for most individuals. The tax charge was designed to prevent excessive new pensions savings being put in place in advance of the 2011 measures to restrict pensions tax relief. 2. Where did Labour get to? The framework for the new high income excess relief tax charge on pension savings (the HIER charge ) was set out in the Finance Act However, much of the detail (and the more difficult provisions) were left for further consultation and future legislation, either in Finance Bill 2011 or via regulations. This means that policy on the detail will, in any event, be decided by the Coalition Government, if they stick with the current approach. There is still significant work to be done by HMRC and the new Government, including decisions on a number of difficult points of detail, if the new tax charge is to be implemented in April This leaves limited time for the pensions industry to respond. 3. How will the HIER charge work (Labour s proposals)? The new tax charge is designed to limit tax relief on pension contributions and accrual for high income individuals to the basic rate of tax, with effect from 6th April, High income individuals are individuals with gross incomes subject to UK tax of 150,000 or S L A U G H T E R A N D M AY 8

9 more (and for this purpose the value of any pension provision funded by the employer counts towards the threshold). However, there is an income floor. Individuals with incomes subject to UK tax of less than 130,000 (ignoring the value of employer pension provision, but after adding back unprotected salary sacrifices and flexible remuneration arrangements) are not caught by the new tax charge. 2 These income tests will generally be applied on a current year basis. There is (as currently legislated) no look-back to previous tax years (unlike under the special annual allowance charge). An exception was proposed by the Labour Government, so that a one year look-back would apply in the year of drawing benefits. This was expected to be legislated for in Finance Bill Gross income includes all income, from employment, investments or otherwise. For both the 150,000 test and the 130,000 floor, where the net pay arrangement is used to deliver tax relief on member contributions, those contributions are added back when calculating gross income, together with any payroll giving. Some reliefs (but not all) are applied. For example, charitable giving is ignored. 3 These timings were proposed by the last Government and may shift or change, depending on how the new coalition government decides to proceed with the HIER charge. Unlike the special annual allowance charge, there are no allowances or protections for pre-existing pension arrangements either in the current legislation or the pipeline. If an individual is caught by the income thresholds, the new tax charge will apply. The tax charge will be set at a maximum of 30% 4 for individuals with gross incomes of at least 180,000. For individuals with incomes of between 150,000 and 180,000, the tax charge is tapered down, with a step down of 1% for every 1,000 of income down from 180,000. The taper is included in the current legislation. The restriction of relief is intended to be delivered via self-assessment. Reporting will primarily, therefore, be the responsibility of the individual. However, the complexity of the new measures means that however light touch the legal requirements on schemes and employers are, in reality scheme members will require 4 The actual rate of tax charged is gauged to ensure that basic rate relief at 20% is given where the gross income is 180,000 or more, even if the individual s income does not all fall within the highest tax bracket. Where the individual s reduced net income (which is the measure used to calculate the individual s actual tax) together with the pension savings amount is less than the higher rate limit for income tax purposes (which will initially be set at 150,000), the starting rate of the HIER charge is reduced to 20%, or 0%, as appropriate, on tranches of the pension savings amount which fall into the 40% or 20% tax brackets, to ensure that basic rate tax relief is still given. significant support to manage their own reporting obligations. The new information obligations were expected to be set out in draft regulations (currently timetabled for autumn 2010). Defined benefit accrual will be valued by reference to age-related factors ( ARFs ). These will vary by reference to both age and normal pension age ( NPA ). Although the principle of using ARFs on this basis was set out in the Finance Act 2010, the factors themselves are to be set out in regulations. The Labour Government proposed that a public consultation would be carried out by the Government Actuary s Department on the actuarial assumptions underlying the ARFs. Where different tranches of a member s benefit have different NPAs (for example, due to equalisation of pension benefits post Barber) each tranche will attract a different ARF. Further consultation was expected on the implementation of this, with the detail to be set out in regulations. 4. Collecting the HIER charge scheme pays The individual will be responsible for paying the charge, but may not have funds readily available to meet a substantial additional tax bill. The Labour Government s proposed solution to this was to give individuals who incur a tax charge of S L A U G H T E R A N D M AY 9

10 over 15,000 the option to require the scheme to meet the tax bill on their behalf, with their accrued benefits being reduced accordingly. Scheme pays was to apply to both defined benefit and defined contribution schemes. The mechanism for this was not included in Finance Act 2010 and was expected to be included in Finance Bill Before 6th April, 2010: 100 gross employer contribution No tax on contributions 100 in scheme 25 tax free lump sum 45 pension value after tax 70 This feature of the proposals is likely to be particularly onerous for defined benefit schemes. If high income individuals stay in the scheme after 5th April, 2011, effectively schemes will be obliged to operate procedures akin to pension sharing orders on an annual basis (with a pension debit set up which corresponds to the amount paid by the Scheme equal to the individual s HIER charge for that tax year). This is likely to be complex, time consuming and expensive. From 6th April, 2011: 100 gross employer contribution 30% tax on contribution 70 left in scheme tax free lump sum pension value after tax In the private sector, the prospect of these additional administrative burdens will be a factor in considering whether registered pension schemes remain an appropriate option for high income individuals. However this is unlikely to affect public sector schemes, where the administration costs are borne by the tax payer. 5. Is pension accrual in a registered pension scheme still attractive? Pension savings through registered pension schemes are going to be significantly less attractive for higher earners once the HIER charge applies. For the purposes of the above simplified examples we have made the following assumptions: 1. Assume no investment growth from time of contribution being made to paying benefits. 2. Treat pension as though capitalised, paid and taxed on retirement. 3. Before 6th April, 2010 tax on pension assumed to be at 40%. 4. From 6th April, 2011 tax on pension assumed to be at 50%. 5. Assume scheme pays operates from 6th April, S L A U G H T E R A N D M AY 10

11 The scheme pays proposal is also likely to impose significant administration burdens on pension schemes, particularly defined benefit schemes. In light of this changed landscape it is perhaps unsurprising that many employers are reconsidering their overall remuneration packages, and whether to offer employees alternative benefits for retirement planning. 6. Providing other benefits: some examples Cash: Employers may consider offering cash as an option in place of continued membership of a registered pension scheme. Before 6th April, 2010: Employer pays employee 100 gross cash. Employee s net receipt (after tax at 40% and NICs at 1%) is 59. Total gross cost 5 to employer (including NICs at 12.8%) is From 6th April, 2011: Employer pays employee 100 gross cash. Employee s net receipt (after tax at 50% and NICs at 2%) is 48. Total gross cost 6 to employer (including NICs at 13.8%) is Comment 1: The immediate access to the cash and the freedom to invest it as the individual wishes may be attractive to individuals. However, the individual will (depending on the investments chosen) generally suffer tax on investment returns, unlike the tax free roll up available in a registered pension scheme. Comment 2: However, paying an individual cash that corresponds to the value of defined benefit accrual foregone will, if calculated actuarially, give rise to age discrimination issues which will need to be considered carefully. EFRBS: Another option would be to offer an unfunded promise to pay benefits on retirement or death. This is an unregistered employer financed retirement benefits scheme ( EFRBS ) for tax purposes. There is no income tax or NICs on the provision of the promise, but all benefits paid out, including lump sums, are taxable (but no NICs are payable if benefits are right shape 7 ). There is no corporation tax deduction until benefits are actually paid. From 6th April, 2011: Employer pays 100 on retirement Employee receives taxable lump sum, net Employer receives taxable pension, net Total benefit For the purposes of the above example we have made the following assumptions: 1. Treat pension as though capitalised, paid and taxed on retirement. 2. Assume tax on benefits at 50%. 3. Assume benefits are paid in right shape to ensure no NICS charge: pension must be paid for life and lump sum calculated in same way as for a registered scheme. Comment 1: The unfunded EFRBS may be attractive as there is no immediate tax charge when the benefits are promised. However, the individual assumes the risk of the employer becoming insolvent (which can be managed through the use of security) and the employer s 5 i.e. before corporation tax deduction. 6 i.e. before corporation tax deduction. 7 i.e. in the same shape as for a registered pension scheme. S L A U G H T E R A N D M AY 11

12 corporation tax deduction is deferred, and only made available as and when benefits are paid. Comment 2: An unfunded defined contribution EFRBS may, however, provide a way of dealing with the age discrimination concerns that would otherwise flow from paying cash where the amount of cash paid varied by age. Comment 3: The tax free roll up available in a registered pension plan may remain attractive, compared to the unfunded EFRBS promise, depending on the individual s time horizons. This may lead employers to consider offering money purchase registered scheme benefits, rather than defined benefits, because scheme pays can be more easily accommodated in a money purchase arrangement. 7. Providing other benefits the anti-avoidance provisions The inclusion of a wide-ranging anti-avoidance provision in the Finance Act 2010 has made sensible planning for remuneration changes difficult. Where the provision applies, the member is treated as though the registered scheme pension provision foregone has in fact been made and the HIER charge is applied accordingly. The provision is so widely drafted it could be read as applying even where high income members of registered pension schemes are offered cash as a benefit option. To date, HMRC have not issued any guidance on how they will operate this anti-avoidance provision in practice, to put this point to rest. The anti-avoidance provision could also be read as applying where EFRBS benefits are given. 8 And in addition, the Labour Government said at Budget 2010 that they would take action to tackle the use of trusts to avoid, defer or reduce income tax or NICS or to avoid restrictions on pensions relief. There is therefore uncertainty at present as to whether the provision of an EFRBS benefit will be treated by HMRC as avoidance under the existing provision, or whether further legislation might attack the EFRBS model. Our view is that choosing an onshore unfunded EFRBS option over continued membership of a registered person scheme is unlikely to be avoidance under the existing provision, since the individual is choosing a separate tax regime provided for in legislation (and which is already utilised in the public sector in some 8 We requested an early statement of HMRC s attitude to EFRBS in our comments given during the consultation process. Click here to view these comments. instances, such as the Judicial Pensions Scheme). However, the position should be confirmed with HMRC, in the absence of guidance from them. The same arguments can currently be made for offshore funded EFRBS. (These have in summary, a similar tax treatment to onshore unfunded EFRBS, but investment rollup can be tax free, and pensions paid from them are currently 10% tax free on receipt in the UK). However, having regard to the Budget deficit, and the previous government s statements on the use of trusts, there is, in our view a greater risk that the tax treatment of offshore EFRBS will be changed either in the Budget or subsequent legislation. 8. Points to watch The consultation response paper issued by HMRC in March at Budget 2010 contains an array of detail on points that are likely to be of interest. We have highlighted some of these below. Redundancies: Where an employee is made redundant, the Labour Government s proposal was that any redundancy payment over the 30,000 tax free amount would count towards the income thresholds. This could mean lower paid individuals suffer a HIER charge in the year of redundancy, simply because their redundancy package takes them over the 130,000 income threshold in that S L A U G H T E R A N D M AY 12

13 year. However, the door was left open to reconsider this approach if an option could be found that was not vulnerable to avoidance opportunities. We suggested some possible approaches to the issue in our comments given during the consultation process. Click here to view these comments. Serious ill-health/death: The HIER charge will not apply where a member draws a serious ill-health lump sum or dies. Although the Labour Government intended to legislate for these matters in Finance Act 2010, in the event the Act did not include such provisions. Ill-health enhancements: The Labour Government also invited proposals for dealing with ill-health enhancements, and was open to re-considering the issue if it could be addressed without creating avoidance risk. Pension increases: Where schemes have particularly generous pension increases the Labour Government proposed adopting an ARF adjustment to reflect the additional value those individuals receive. This would presumably be covered in the ARF regulations. NPAs: The concept of normal pension age used in the legislation is the age at which the individual is unconditionally entitled to benefits under the arrangement without any reduction on account of age. In some schemes, this age may differ depending on whether the member retires from active service (where it is typically earlier, say 55) or deferred status (where it is typically later, say 60). The NPA proposed to be used for the HIER charge is the deferred NPA. If the member then retires from active service, this can result in a large accrual for HIER purposes in the final year with a commensurate tax charge. The Labour Government said that these cases required further consideration. Calculating the deemed contribution: The calculation of the defined benefit deemed contribution would be a complex matter for the individual. The Labour Government therefore decided schemes should be obliged to make the calculation and provide details to the individual. It was intended that the obligation would be set out in regulations. Negative deemed contributions: Under defined benefit arrangements, where individuals have low salary growth and long years of service, the deemed contribution for the HIER charge may turn out to be less than the employee s own contribution. The Labour Government initially stated that negative contributions would not be recognised but backtracked on this after the consultation process, stating that negative contributions would be given fair recognition. This issue was expected to be dealt with in future legislation. 9. Next steps Hopefully, the Coalition Government will make its position on the proposed restriction on pensions tax relief known on 22nd June, in the Budget. Employers will then have to consider carefully whether to offer cash or other benefit options for retirement planning, bearing in mind the additional burden of scheme pays if they continue to sponsor defined benefit registered pension schemes. This window for consideration will be short if the regime (or a modification of it) commences as expected on 6th April, S L A U G H T E R A N D M AY 13

14 Preserving the power to repay surplus: action required A. Introduction 1. Transitional provisions that permit trustees to amend their rules by resolution to maintain a power for ongoing schemes to repay surplus to employers expire on 5th April, Schemes that currently contain such a power will lose it unless: their trustees resolve to maintain that power prior to that date, and various other conditions are complied with. 2. The forthcoming deadline has put the spotlight on these transitional provisions, found in Section 251 of the Pensions Act It is also appropriate to consider whether those transitional provisions will apply: 2.1 not only to repayments of surplus from ongoing schemes, but 2.2 also to repayments from schemes that are winding-up. 3. The possibility, however remote, that, unless the power to repay surplus on a winding-up is specifically preserved by trustee resolution such power will be lost, has a knock-on effect on how surplus is recorded in the sponsoring employer s balance sheet. 4. We understand that the point at 2.2 has been raised with the DWP, which is looking at the issue with its lawyers. 5. Our views on the point at 2.2 above are in Sections D. and F.2 below. B. Background 1. Repayment of surplus from an ongoing scheme 1.1 The Pensions Act 1995, as amended, regulates in different ways the treatment of a repayment of surplus from a tax approved occupational pension scheme: where the scheme is an ongoing scheme, and where the scheme is winding-up. 1.2 The legislative requirements to be complied with in relation to an ongoing scheme are that a repayment of surplus may only be made if: there is a power in the scheme permitting repayment while the scheme is ongoing (this is discussed further in 2. below), the scheme is in surplus on a buy-out basis (i.e. the liabilities are valued by reference to the cost of securing them with an insurance company), Comment: There is no need for the liabilities to, in fact, have been secured through the purchase of annuities or deferred annuities from an insurance company. the proposed repayment does not exceed the surplus as certified by the actuary, the trustees are satisfied that it is in the interests of the members of the pension scheme that the repayment of surplus occurs, and S L A U G H T E R A N D M AY 14

15 not less than 3 months prior notice of the repayment of surplus has been given to members of the scheme. Comment 1: It would usually only be in the interests of members if some part of the surplus has been used to provide benefit improvements. Comment 2: However, if the scheme is fully funded on a buy-out basis the employer could consider winding the scheme up (this is discussed further in 4 below). 2. Issues relating to the power to repay surpluses from an ongoing scheme: Part I 2.1 In the case of a scheme established prior to 6th April, 2006, if the scheme s rules prior to 6th April, 2006 allowed repayments to be made to the employer out of a surplus while the scheme was ongoing, then that power will no longer be exercisable after 6th April, 2006 unless the trustees by resolution: revive that power, or revive it in a modified form under the transitional provisions contained in Section 251 of the Pensions Act Under these provisions, the trustees may by resolution: permit the continued use of that power (subject to compliance with the requirements of Section 37 of the Pensions Act 1995 see 1.2 above) with any appropriate updating requirements to reflect the change in tax regime, or modify that power to repay surplus so that it is exercisable only in such circumstances and subject to such conditions as the trustees may determine in the resolution. 2.4 However, the trustees may only make such a resolution if they are satisfied that it is in the interests of the members of the scheme to do so. 2.5 Furthermore, the power of the trustees in Section 251 may not be exercised except in the following circumstances: it may only be exercised once, and notice of the intention to exercise the power must be given to the members at least 3 months before the proposed exercise of power takes effect. 2.6 The power in Section 251 will expire on 5th April, 2011 if not exercised before that date. 2.7 If there was no pre-existing power on 5th April, 2006 to repay surplus from an ongoing scheme established prior to 6th April, 2006, then it is no longer possible for a repayment of surplus to be made from an ongoing scheme (even if the scheme s existing power of amendment is wide enough to allow an amendment to be made to permit a repayment of surplus). 2.8 However, if faced with such a restriction, it may be that the alternative way to proceed is to wind-up the existing scheme and repay the surplus on wind-up (see further 4. below). 3. Issues relating to the power to repay surpluses from an ongoing scheme: Part II 3.1 One question to consider is whether it would, in fact, be in the interests of the members for the trustees to make the resolution required under Section 251 in order for an existing S L A U G H T E R A N D M AY 15

16 power to repay surpluses from an ongoing scheme to continue to be available after 5 th April, The position can be viewed as a straightforward decision for trustees: (a) if they take no action, then this power to repay surplus from an ongoing scheme lapses. Comment: This means that the trustees have then lost the opportunity, if the circumstance arises, to agree to this course of action with the potential for benefit improvements for members before the surplus is repaid, (b) if the trustees decide to pass the resolution, then it is still necessary for the requirements of Section 37 to be complied with before a surplus may be repaid from the ongoing scheme. Comment: Since Section 37 says that the trustees may only permit a repayment of surplus from an ongoing scheme if the trustees are satisfied that it is in the interests of the members of the scheme that the repayment of surplus occurs, the trustees can then decide, at the time in question, whether it is or is not in the interests of the members concerned in the light of the facts and circumstances prevailing at the time in question, including: any benefit improvements that may be available, and the extent to which the scheme s assets are, in fact, applied to hold a buy-in policy In our view, trustees should have little difficulty in concluding that it is in the interests of the members to pass the resolution. 4. Repayment of surplus when a scheme is being wound-up 4.1 Where a scheme is being wound-up, the requirements to be complied with before a surplus may be repaid are as follows: 1 Which would mean that, subject to credit risk on the insurer issuing the buy-in policy, the scheme s assets match the scheme s liabilities (leaving to one side any future service accrual if the scheme still allows benefits to accrue for future service for active members on a defined benefit basis). (a) the scheme liabilities have been discharged (either bought out with an insurance company or transferred to another scheme), (b) there is a power in the scheme to distribute assets to the employer on the wind-up, (c) at least 3 months prior notice has been given to the members of the scheme of the proposal to exercise the power to repay surplus to the employer, (d) the Pensions Regulator has not, before the scheduled date for repayment, served a notice on the trustees to the effect that power to repay the surplus should not be exercised until the Pensions Regulator has confirmed in writing that he is satisfied that the requirements laid down by legislation for the repayment of surplus have been satisfied, and (e) the Pensions Regulator has confirmed, before the repayment of surplus, that the Regulator does not propose to act, as set out in (d) above. S L A U G H T E R A N D M AY 16

17 5. Requirements imposed by the Finance Act The Finance Act 2004 restricts the types of payments that may be made from a registered pension scheme (i.e. one which has UK tax approval). 5.2 If the type of payment does not fall within one of the permitted categories of authorised payment, then there are various adverse tax charges that apply. 5.3 One type of authorised payment is an authorised surplus payment. 5.4 A payment which is made in compliance with the requirements of Section 37 (see 2. above) or Section 76 (see 4. above) of the Pensions Act 1995 would be an authorised surplus payment. 5.5 On making an authorised surplus payment there is a freestanding 35% tax charge on the authorised surplus payment. The authorised surplus payment is not otherwise treated as income for UK tax purposes of the employer. C. Does Section 251 apply additionally to surpluses from schemes in wind-up?: Part I 1. It is clear from the explanatory notes accompanying Section 251 that it is intended to apply only to the power to replay surpluses in ongoing schemes under Section 37 of the Pensions Act However, on initial examination, Section 251 may lead to the conclusion that it also applies to repayment of surplus on a scheme winding-up. 3. Section 251(1) reads as follows: 251 Payment of surplus to employer: transitional power to amend scheme (1) This section applies to a scheme which immediately before the commencement of section 250 was one to which section 37 of the Pensions Act 1995 (c. 26) applied (see subsection (1) of that section, as it then had effect). (emphasis added) 4. From 6th April, 1996 until 5th April, 2006 Section 37(1) provided: (1) This section applies to a trust scheme if- (a) (b) (c) apart from this section, power is conferred on any person (including the employer) to make payments to the employer out of funds which are held for the purposes of the scheme, the scheme is one to which Schedule 22 to the Taxes Act 1988 (reduction of pension fund surplus in certain exempt approved schemes) applied, and the scheme is not being wound up. (emphasis added) 5. Let us now re-write Section 251 by looking at how it would read if we inserted the words from Section 37(1) of the Pensions Act 1995 as in force on 5th April, In this situation Section 251(1) would read, in relation to a scheme in existence on 5 th April, 2006, as follows: (1) This section applies to a trust scheme if- (a) (b) apart from this section, power is conferred on any person (including the employer) to make payments to the employer out of funds which are held for the purposes of the scheme, the scheme is one to which Schedule 22 to the Taxes Act 1988 (reduction of pension fund surplus in certain exempt approved schemes) applied, and S L A U G H T E R A N D M AY 17

18 (c) the scheme is not being wound up. (emphasis added). 6. The argument (the Preliminary Interpretation Argument ) is that the words: (c) the scheme is not being wound up. referred to in 5 above, should be read as: (c) the scheme is not being wound up on 5th April, (emphasis added) 7. It follows from the Preliminary Interpretation Argument, if correct, that where the scheme starts to wind-up after 6th April, 2006, then Section 251 will apply to it. 8. If the Preliminary Interpretation Argument is correct, any scheme which had a power prior to 6 th April, 2006 to repay surplus on a winding-up will lose that power unless a resolution reviving the power to repay surplus or reviving it on a modified basis is passed before 6 th April, D. Does Section 251 apply additionally to surpluses from schemes in wind-up?: Part II 1. The argument, which we consider to be correct, is that Section 251(2) can only apply if the scheme existed on 5th April, 2006 and if it is not being wound-up at the time the surplus is to be repaid. It is incorrect to say that the words in paragraph (c): the scheme is not being wound up should have imported the additional words on 5th April, There is no policy reason to depart from the natural reading of the words in Section 251(1) or to import the words in to paragraph (c) so that it reads: (c) the scheme is not being wound up on 5th April, In addition, the Preliminary Interpretation Argument is not consistent with: the logical structure of the Pensions Act 1995 (distinguishing between repayments of surplus from ongoing schemes (Section 37) and repayment of surplus from schemes in winding-up (Section 76)), or the purpose of the amendments as indicated in the explanatory notes to the Pensions Act Furthermore the Finance Act 2004 affected only Section 37. It had no material impact on the Section 76 regime. There was no need to amend Section 76 in this way to take account of the new tax regime. 5. This analysis is borne out by the Hansard debate. 6. It is also worth considering the position of schemes established after 5th April, 2006 (ie. outside the scope of Section 251). Could such a scheme be established on terms that it could: (a) allow for a refund to surplus from an ongoing scheme in the circumstances permitted by Section 37 (as inserted by Section 250 of the Pensions Act 2004), and (b) provide for surplus to be repaid on winding-up in circumstances allowed for in Section 76 of the Pensions Act 1995? 7. The answer is, in our view, yes. Section 251 only applies to schemes established prior to 6th April, S L A U G H T E R A N D M AY 18

19 E. Why does it matter? 1. Although very few schemes are currently in surplus, and the prospect of schemes ever having a surplus that could be paid to the employer may seem remote, retention of the power to repay remains important. 2. First, the issue arises in funding negotiations, when trustees may persuade the employer to increase contributions on the basis that, should the scheme subsequently move into surplus, the trustees will be able to repay the surplus. 3. Second, IFRIC 14, effective for accounting periods beginning on or after 1st January, 2008, gives guidance on how to assess the limit in IAS 19 on the amount of surplus that can be recognised as an asset in the balance sheet of a sponsoring employer. 4. Surpluses can be recognised only if the sponsoring employer has an unconditional right to realise them at some point. 5. IFRIC 14 distinguishes between surpluses that are available to the sponsoring employer: in the form of repayments, and in the form of reductions in future contributions (a contribution holiday ). 6. If a surplus can be consumed through a future contribution holiday, then it can be included in the balance sheet as a pre-payment. In contrast, if it cannot be consumed by a contribution holiday, then the excess can only be included in the balance sheet as an asset if it can be recovered by repayment on winding-up of the scheme. F. Action required 1. Schemes with power to repay surplus while the scheme is ongoing 1.1 If such schemes wish to preserve their power to repay from the ongoing scheme, they must go through the Section 251 resolution procedure before 6th April, Given the notice requirement referred to in 1.2 below, this means taking action before the end of this year. 1.2 This will involve the following steps: Step 1: Give members 3 months notice of the trustees intention to pass the Section 251 resolution. Where convenient, this can form part of a general member communication (for example, an annual communication exercise) so long as notice is provided to all members. For Section 251 purposes, member includes active, deferred, pension and pension credit members, Step 2: Send written notice of the trustees intention to pass the Section 251 resolution to the employer, and Step 3: Once the 3 month notice period has expired, the trustees pass the Section 251 resolution. 1.3 In order to pass the Section 251 resolution, the trustees must be satisfied that it is in the members interests. 1.4 However, as noted in B.3 above, this should be an easy decision for the trustees to take, given that they still have to be satisfied, if they subsequently exercise the power to repay surplus in accordance with Section 37, that it is in the interests of members of the scheme that the repayment of surplus occurs from the ongoing scheme. 2. Schemes with power to repay surplus on a winding-up 2.1 In our view, Section 251 does not apply to the surplus repayable on the winding-up of S L A U G H T E R A N D M AY 19