Pensions A-Day - Revenue may decide who your friends are!

HM Revenue & Customs (HMRC) has produced draft internal guidelines encouraging tax inspectors to establish whether or not an employee is a 'close friend' of the controlling director of a firm before allowing tax relief for pensions contributions made in respect of an employee, warns PKF accountants and businesses advisers.

Under current tax rules, it is relatively straightforward for businesses to claim a tax deduction from their profits in respect of pension contributions made for employees. For accounting periods ending after 5 April 2006, this expense will only be deducted if the business can demonstrate that it is incurred "wholly and exclusively" for a business purpose such as attracting and retaining valued employees.

The proposed rules can be found in draft sections of HMRC's Business Income Manual that deals with employers' deductions for pensions contributions paid for employees. They require tax inspectors to establish whether or not a pension contribution is paid for a non-trade purpose, i.e. whether it benefits the employee more than the business.

Peter Penneycard, national director of tax at PKF, said: "This is the latest example of HMRC paring down potential A-day tax advantages before they come into force. Whilst HMRC suspicions are often raised when relatives of the controlling director are employed in a company, how is an inspector supposed to tell which employees are friends of a controlling director? Provided the total cost of the salary package reflects the individual's value to the company, it should not matter to the company if senior employees choose to be rewarded by means of pension contributions rather than salary."

"If these draft instructions are adopted, the whole area of pension contributions could become a minefield for small companies. At a time when the Treasury is exhorting people to make better provision for their retirement, HMRC should not be deterring employers from making pension contributions. We urge the Government to use the Budget as an opportunity to stop these mixed messages and announce revised guidance."