Treasury consults on pensions tax relief administration

The Treasury is consulting on how to plug a loophole in the way pensions tax relief operates, which means around 1.75m lower paid workers saving in a pension may end up in differing financial positions depending on how their scheme is administered

The call for evidence, which was announced at Budget 2020, seeks views on how the discrepancy in outcomes for low earners can be addressed in a way that is consistent with the government’s principles for reform.

The problem arises because although many pension schemes relief at source (RAS) on pension contributions, other pension providers add this money through a net-pay arrangement.

Those in a RAS pension scheme and who do not pay tax on their take home pay (because their taxable income is below the personal allowance) still receive a payment into their pension equivalent to tax relief at the basic rate, like all other savers in RAS pension schemes. As they do not pay tax, this is effectively a government top-up paid into their pension.

However, lower earners who are in a net-pay scheme have their contributions taken out of their pay before tax is calculated. If their remaining pay after their pension contribution is below the personal allowance, then they do not receive the same top-up that lower earners in RAS schemes receive.

The RAS scheme assumes that the individual will have paid at least basic rate tax on all of their pension contribution, whereas this individual in the net-pay scheme would only have paid basic rate on part (or even none) of their pension contribution had it been taxed as income.

As a result, lower earners in a net-pay scheme, earning less than the £12,500 threshold for paying tax, do not receive the top-up that lower earners in RAS schemes receive. This creates a difference in tax treatment depending on the method of tax relief used in the pension scheme of someone who does not pay income tax.

The Treasury’s consultation paper states: ‘To date a proportionate and straightforward solution to address the difference in treatment for low earning pension savers has not been found.

‘There is a balance to be struck between ensuring consistency in outcomes and ensuring simplicity for individuals.

‘The options considered in this call for evidence all have drawbacks and would introduce significant complexity into the pensions tax regime for employers and pension schemes.

‘Any changes would be difficult to explain to individuals and are likely to lead to greater engagement with HMRC by individuals who would otherwise have no need to contact them.’

The consultation considers four main approaches. These include HMRC paying a bonus to low earning savers based on PAYE real time information (RTI) data; a standalone charge on RAS schemes to recover the top-up given under the RAS method of tax relief where tax is not paid; employers operating multiple schemes; and mandating the use of RAS for all defined contribution schemes.

The publication of the call for evidence has been welcomed by the Low Incomes Tax Reform Group (LITRG), which is a member of the Net Pay Action Group, made up of pension providers, lawyers, tax specialists, payroll specialists, employers, consumer groups and policy experts.

The Net Pay Action Group has warned that this issue threatens to damage public confidence in auto-enrolment and risks widening the gender pensions gap, since women are disproportionately represented among lower paid earners, making up 75% of the 1.75m total, according to evidence given to the public accounts committee.

Victoria Todd, head of LITRG, said: ‘However, we note with some concern that one of the possible solutions put forward is to remove tax relief for non-taxpayers who receive it by virtue of RAS schemes.

‘It is comforting that the call for evidence notes that “the government is not minded to proceed with this approach” and we hope that this possibility will quickly be ruled out altogether.

‘Any solution should ensure a levelling up rather than down so that existing tax relief is extended to those missing out rather than taken away from others who benefit from it.

‘LITRG’s proposed fix to the problem is that HMRC use data they already have, collected via the PAYE RIT system, to identify those taxpayers affected and make a payment to them equivalent to the tax relief they would have received in a relief at source scheme.

‘We look forward to engaging with the call for evidence to make the case for this.

‘It is time for the government to move forward and end this injustice that affects so many people on low incomes.’

The consultation closes on 13 October.

Pensions tax relief administration: call for evidence

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