Employer contributions and tax relief

Controlling directors can control how much remuneration they take from the business and the proportion that is taken in the form  of salary, bonus, dividends and pension contributions. In particular, a controlling director may decide to take a small salary and the bulk of their remuneration as dividends for tax and National Insurance reasons. Does that mean they have restricted the scope for tax relievable employer contributions?

The short answer is no. As long as it can pass the 'wholly and exclusively' test, an employer contribution will benefit from corporate tax relief.

The first step for HMRC is to establish whether the level of the total remuneration package, so things like salary, bonuses, commission, benefits in kind and pension contributions is commercially reasonable for the work done. Where a controlling director is the driving force behind the company and whose work generates the company's income (for example,  where the controlling director is the sole owner and employee), the level of the remuneration package is a commercial decision and is unlikely to fail the test. A large employer pension contribution (in comparison to salary) may therefore be able to be claimed as an expense of the company.

However, the employer's contribution is deducted from the employer's trading profits for tax purposes and can normally only be applied to the period of account in which it is paid.

Where an employee is unconnected to the employer it is likely the remuneration package will be at a commercially reasonable level.

Where the employee is a non-controlling director or a friend or relative of a controlling director, HMRC may want to be satisfied the package is not unreasonable. If the package is in line with that paid to unconnected employees, it will normally be accepted as reasonable but if precise comparisons are not possible, HMRC will carefully consider the facts to establish whether or not the package is commensurate with the work done. If it appears the spouse or relative's package is actually part of the controlling director's own remuneration, the payment may be taxable as earnings of the director, despite being wholly and exclusively for the purposes of the trade.

As we have seen, where an employer has committed to provide employees with a pension as part of their remuneration package, the  costs of meeting the commitment are normally tax deductible as an expense of the trade.

This can apply even where the decision or need to make the pension contribution happens after:

• the employees retire or leave the employer's service
• the employer ceases to trade
• the employer sells the business in which the employees work

The crucial point is whether or not the employer has agreed to make pension contributions as part of the employment package.

An employer can only receive tax relief on a pension contribution if it's made on behalf of an employee (or in some circumstances an ex- employee).

A contribution can be made by a company on behalf of someone other than an employee (say the spouse or child of a controlling director) but such a contribution would be regarded as a third-party contribution. A third-party contribution is treated as if it had been made by the individual who would benefit from the relevant tax relief, as set out in pension contributions - all you need to know - the employer wouldn't be able to receive corporate tax relief.