Ordinarily it is clear whether a contribution is being made by an individual, third party or employer. However, sometimes identifying individual or business contributions is difficult.
Who is making the contribution?
Identifying whether an employer or individual is making the contribution determines how tax relief is given and the amount. If not identified correctly it can result in confusion and wasted time and effort in rectifying the situation.
We will begin by outlining the three sources of contributions in relation to relief at source schemes.
Individual contributions receive tax relief up to the individual’s highest marginal rate. Basic rate relief is applied by the provider up to a maximum of 100% of the individual’s Relevant UK Earnings or £3,600 if higher. Higher rate relief is available to the individual to the extent that they have paid higher rate tax. It is usually claimed by the individual through their self-assessment return or by an adjustment to their tax coding (further information on higher rate relief is available here).
A person other than the individual or the employer can make a pension contribution for the individual. That could be a person, a corporate body or other legal entity. The contribution will be treated for tax purposes as though it was made by the individual themselves. Therefore the individual will receive the tax relief due rather than the person who made the contribution.
Employer contributions are paid gross to the pension scheme. They are put through a company’s accounts as a business expense, as part of the overall costs of employing staff, which is offset against profits before they are assessed for corporation tax (further information on employer contributions is available here).
A sole tradership is the simplest business entity, whereby the business and the individual are the same legal entity. They are typically one-man enterprises without any employees (but there is nothing stopping them taking on employees).
The sole trader is self-employed. As the business owner the individual carries the personal responsibility for the debts and obligations of the business. If the business runs into difficulty so does the individual, which means their personal assets may be at risk.
A sole trader can make employer contributions in respect of any employees but not for themselves. If they make employer contributions in respect of their employees these are tax relievable as a business expense against the sole traders’ pre-tax profits subject to 'wholly and exclusively' rules.
As sole traders can only make individual contributions in respect of themselves they are limited to 100% of their pre-tax profits (effectively their Relevant UK Earnings).
Like a sole trader, a partnership is not a separate legal entity. Partners of a partnership are carrying on a business in common with a view to making a profit, and will need to register as self-employed. All partners are equally financially responsible for the debts incurred by the business, which means that creditors can claim the personal assets of a partner even though the debts may have been incurred by another partner.
It is up to the partners how much of the profits they take. They will be taxed on their share of the profits, as well as Class 2 and 4 National Insurance Contributions.
Like sole traders, partners are self-employed and cannot make employer pension contributions for themselves. Partners’ individual pension contributions are limited to 100% of their Relevant UK Earnings (which is equivalent to their share of the partnership's profits). Any higher rate relief can only be claimed by the partner from HM Revenue & Customs (HMRC). Contributions for partners can be made from the business account of the partners, but a pension provider may insist on verifying the identity of all the partners of the partnership as part of their acceptance process.
Partnerships can make employer contributions for their employees.
Limited Liability Partnership (LLP)
An LLP is similar to a partnership, described above, except that the LLP is a separate legal entity and like a Limited Company limits the amount of liability its partners have to the amounts they have invested in it. As with an ordinary partnership each partner must register as self-employed. They are taxed in the same way as the partners of a normal partnership.
What happens if a mistake occurs?
A contribution by a sole trader or partner from a business bank account of a partnership could be mistakenly treated as an employer contribution by the pension provider. Tax relief will not have been claimed on the contribution as a result. To resolve this issue it would require the provider to recognise that the individual has made the contribution and obtain the correct basic rate relief from HMRC.
Similarly, a sole trader or partnership could mistakenly make an employer contribution for a self-employed individual claiming tax relief by treating the contribution as a business expense deductible from their profits. As a consequence profits may be understated to HMRC. Where this is discovered the business will have to come to some agreement with HMRC to pay the tax due and any interest or penalties that may apply.
It is usually evident who is making a contribution but where doubt exists it is vital to make the provider aware of whom it is. Where it does not appear clear cut, checks with the client and/or their accountant are key to preventing any errors and expense of rectifying the situation.