Out-Law Legal Update | 01 Jan 2008 | 11:06 am | 5 min. read
But members who pay too much may not get the tax breaks that they hoped for. And those who breach the limits on when and how they take benefits will suffer severe tax penalties.
No, not necessarily. HM Revenue & Customs have not published a full list of unauthorised payments, presumably because that might give the unscrupulous ideas on how to get money out of a scheme.
Helpfully, some payments are described in legislation as “unauthorised”, including assignments and surrenders of annuity payments, excessive loans from the pension scheme to employers operating the scheme and “value shifting” (passing the value of assets from a registered pension scheme to members or employers without actually creating a payment). However, other payments are caught by the unauthorised payments rules purely because they do not meet the criteria set for authorised payments.
The most common unauthorised payments are:
There are other types of unauthorised payments which are less common simply because the contracts involved cover a smaller number of members. For example:
The excessively complicated rules governing trivial commutation of benefits (triviality) result in a very common type of unauthorised payment. These rules apply when a member has only a very small pension entitlement, and trustees are allowed to pay a one-off lump sum instead of having to make trivial regular pension payments. Members often confirm that they are entitled to triviality but then they confirm, after they have received the lump sum, that they have benefits in other schemes meaning that they do not qualify for triviality after all. Unless the member can repay the scheme, the lump sum payment is an unauthorised payment.
From a scheme’s perspective, where a member does not qualify for triviality but there is only a small residual pension, after tax-free cash, paying that small pension is likely to involve disproportionate administration expenses. Small pensions may also be below the minimum value that pension providers are prepared to allow for purchasing an annuity, meaning that trustees may not be able to buy out small pension liabilities. So there are times when schemes may actually prefer to make an unauthorised payment to reduce ongoing administration charges.
Inadvertent payments – genuine errors – identified and corrected as soon as possible do, however, escape the unauthorised payment rules. Recipients of payments would first need to repay anything that would otherwise constitute an unauthorised payment.
The unauthorised payment tax charges are a percentage of the unauthorised payment:
for the recipient of the unauthorised payment, a 40% tax charge + 15% where the unauthorised payment exceeds a certain threshold.
for the scheme, a tax charge of up to 40%, known as a scheme sanction charge, although this may be reduced to 15% where the recipient’s tax liability is paid.
If a scheme makes too many unauthorised payments, HMRC could also de-register the scheme, giving rise to a further tax charge of 40% of the scheme assets.
All in all, a substantial chunk of benefit disappears in tax charges associated with unauthorised payments – tax charges that cannot be offset by any other allowance. However, the 'good faith' principle may mean that schemes can avoid scheme sanction charges in some circumstances.
If a scheme has acted in good faith and followed proper procedures – for example, by giving a member full details of the triviality rules and paying a triviality payment only where the member confirms in writing that he is entitled to one – the scheme should not suffer a scheme sanction charge.
Scheme administrators have to report each unauthorised payment to HMRC in an 'Event Report'. HMRC will then bill the recipient of the unauthorised payment and, if necessary, the scheme for the tax charges. This process is likely to take many months to complete. Pension providers have reported large numbers of unauthorised payments – far more than HMRC anticipated – and would prefer to pay any unauthorised payment tax charges direct to HMRC. Direct payment of the tax would allow transaction records to be completed far quicker, easing for accounting and monitoring requirements; and would bring certainty that the tax liability has been paid, fixing the scheme’s tax liability and allowing the scheme, subject to scheme rules, to deduct the tax and arrange payment to HMRC when an unauthorised payment is knowingly made.
HMRC has been receptive to the feedback it has received on the unauthorised payment requirements. It is looking at ways of simplifying the payment processes and possibly relaxing aspects of the unauthorised payments rules. There has been no announcement from HMRC, but there may yet be some kind of simplification.