UK government challenged to prove pension reforms will not create tax avoidance "loophole"

Out-Law News | 24 Oct 2014 | 5:30 pm | 2 min. read

The UK government has been asked to clarify exactly how much revenue it expects to lose as a result of workers aged over 55 using new pension flexibilities as a means of avoiding income tax.

Journalist John Greenwood told the committee of MPs reviewing the Pension Schemes Bill that the policy, which is due to take effect from next April, would allow workers aged between 55 and 64 to pay all of their salary into a defined contribution (DC) pension before withdrawing it as they wished. Using 'salary sacrifice' to pay all their salary into their pension would allow them to save on income tax and national insurance contributions (NICs), while obtaining tax advantages, he said.

Questioned by the committee during the same evidence session, pensions minister Steve Webb said that the government had put in place measures to prevent the practice, including by making changes to the annual allowance. However, he was unable to say whether specific analysis of the potential tax loss had been carried out by the Treasury when questioned further by shadow pensions minister Gregg McClymont.

Pensions expert Simon Tyler of Pinsent Masons, the law firm behind Out-Law.com, said that the Treasury had identified the potential tax loophole as part of its response to the consultation on the new flexibilities. In order to tackle it, the government will introduce a £10,000 money purchase annual allowance, he said.

"The new annual allowance limits the amount that a pension saver can contribute to any DC pension once they have accessed their DC pension savings under the new flexible pensions regime," he said. "This will limit the extent that the loophole can be exploited, but it isn't a watertight plug."

"What is surprising is that although the Treasury has been quick to identify the additional revenue that the new flexible regime will bring in, it doesn't appear to have calculated with any precision the revenue that may leak out," he said.

From April 2015, the government intends that those aged 55 or over will be able to access their DC pension savings in whatever form that they wish without necessarily having to purchase an annuity, subject to their marginal rate of income tax. It will also remove the 55% tax charge when unused pension funds are passed to a nominated beneficiary on the saver's death.

The draft legislation which will introduce the new flexibilities also includes a 'money purchase annual allowance' of £10,000 that will apply once an individual takes advantage of the new flexibilities. It will limit the amount of tax relief the individual will be able to claim in respect of any further contributions to a DC pension scheme. The overall annual allowance of £40,000 will continue to apply to combined DC and combined defined benefit (DB) pension savings.

In his evidence to the committee, John Greenwood said that the new rules created "a huge risk of widespread tax avoidance".

"If everyone over 55 takes full advantage of them, the Treasury could lose £20 billion in 2015/16 - obviously, that is a massive number," he said. "That will not happen, but if even a tenth of people do, that is still a £2bn loss. That seems to make quite a hole in the Treasury's optimistic projection of making £3bn of profit out of the policy over the five years of the next parliament."

Webb said that the government had "not taken the view" that the practices identified by Greenwood would result in a "big hit on the Exchequer". However, when asked by McClymont whether the government had done any analysis to that effect, Webb was unable to provide an answer.

"The figures that I have seen are the aggregate figures, so I have not seen any breakdown," he said. "In fact, I am not convinced that the figures are done in that way. The Treasury looked at the whole package and came up with a global figure for the expected impact on tax revenues … The figure that we have published is the government's best estimate of the fiscal effect of the reform."