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15 June 2012
Copy by email to:
REF
ACA_to_HMRC_AA_and_FP_carve_
outs_vn8
pensions.policy @hmrc.gsi.gov.uk
TO: Paul Cottis
Please reply to:
Miss K Goldschmidt
Lane Clark & Peacock
30 Old Burlington St
London W1S 3NN
DDI
Fax
0207 432 6622
0207 439 0183
HM Revenue & Customs
Dear Paul
Fixed Protection benefit accrual test and Annual Allowance
“deferred member carve-out”: relevant percentage
At the Budget and as reiterated in HMRC’s Newsletter 53, the government acknowledged that some
parts of the Annual Allowance and Fixed Protection regimes introduced by Finance Act 2011 and
associated regulations do not operate as intended. So changes are being considered by regulation to
both, for formal consultation in Autumn 2012. In order to make the right changes, it is important to be
clear as to how the current legislation works. We are therefore writing to you in relation to one key
aspect where we think there is ambiguity as to what the current law requires, and indeed it may be that
the law is not in line with policy intent.
The issue is the “relevant percentage” and in particular the operation of the “specified rate” when there is a
change in scheme rules (after 14 October or 9 December 2010 as appropriate), in testing for benefit accrual
under fixed protection (FP) and correspondingly for the “carve-out for deferred members’ benefits for the annual
allowance (AA) test.
This issue applies for “defined benefit arrangements” and “cash balance arrangements” but our considerations
and this letter focus solely on “defined benefit arrangements” given their much more common occurrence. We
have not at this stage considered whether the legislation might operate in any different way for cash balance
arrangements.
(For completeness we note that there are a number of other areas of difficulty in discerning the correct
interpretation of the "relevant percentage" definitions which are not covered in this letter. For example, we
wrote to you on 5 February 2012 regarding the operation of these two tests when there is no “specified rate”;
and we know you have had separate enquiries about what can or cannot count as a “specified rate”. We also
think there would be merit in discussions with you on the way many schemes operate revaluation on a
“cumulative basis” – with say a “cumulative index” compared to a “cumulative cap” but we do not pursue that
here.)
ACA is likely to be publishing this letter on the Briefing Papers page of its website (which is open to nonmembers) because it may be helpful to members considering what issues to raise with you for your proposed
regulatory change. Given the short time frame involved, our current intention is to publish at the end of June.
However, it would clearly be helpful if you could review this letter and let us know if you are able to answer our
questions – effectively which of our three readings applies for each of the AA test and the Fixed Protection test
– or indeed if a different reading applies. If it would be useful to aid the consultation process, we would be
pleased to publish any response from HMRC on the same page.
Legislation under discussion
The carve-out for deferred members’ benefits for the annual allowance test is set out in section 234 Finance Act
2004, specifically sub-sections (5B) and (5C).
The equivalent “carve-out” for members from fixed protection “benefit accrual” is set out in paragraph 14 of
Schedule 18 to Finance Act 2011, specifically in sub-sections (12) to (14) of paragraph 14.
Overall, there are areas where the policy intention is not obvious to us. Furthermore, at first glance the wording
of these two sections is very similar, but there are subtle difference that may be significant - so that the “carve
outs” may operate differently under the two versions in unobvious ways, intentionally or unintentionally.
For ease of reference we set out in Appendix 1 the wording of the relevant sections.
Appendix 2 puts the wording of the relevant sections side by side to display any differences more clearly.
1.
Fixed Protection
We first focus on the reference to a specified rate in the Fixed Protection provisions. At the end of the letter we
refocus on Annual Allowance.
Does the Fixed Protection “specified rate” from time to time reflect the scheme rules at 9 December
2010 even if the scheme’s rules are subsequently changed?
DB benefit accrual does not count as arising under Fixed Protection so long as in no tax year does the benefit
value in an arrangement increase by more than the relevant percentage. The latter is defined “The relevant
percentage, in relation to a tax year, means ... —(a) where the arrangement ... includes provision for the value
of the rights of the individual to increase during the tax year at an annual rate specified in the rules of the
pension scheme … on 9 December 2010, that …, and (b) otherwise [a CPI reference explored later] … ,”
The question is the interpretations of these words, if scheme rules are changed after 9 December 2010 and that
change applies to the particular arrangement. We are aware of two interpretations, with different outcomes
(Newsletter 50 Section 9 (repeated in RPSM11101534) does attempt to address this point but, because of the
particular example used, could fit with either interpretation):
•
Interpretation (A) is that (a) continues to apply to the arrangement by reference to the scheme rules as
those rules stood on 9 December 2010 even if the relevant scheme rule then changes.
Say the specific formulation of the rate in the rules in 9 December 2010 is deleted but nevertheless the
benefit value happens to be increased (in the tax year) by the same amount (or less) as would have arisen
under the 9 December 2010 provision - whether because
Page 2
•
the trustees exercise a discretionary power in the current tax year to increase the deferred pension
•
or a newly-introduced provision of a different formula happens to come up with the same or less just
this relevant time.
Interpretation A for this case is that DB benefit accrual would not have arisen, Fixed Protection is not lost.
•
Interpretation B is that, in order for (a) to be called at a particular time in the benefit accrual test and apply
to the arrangement in question, the exact provision (ie rules wording) that was present in the rules on
9 December 2010 specifying a rate must still be in the rules at the time of calling.
We note that under this Interpretation, if the scheme has not made a rule change and the increase granted
is solely in line with the rate specified in the rules, it is clear without calculation that benefit accrual has not
happened; and if either of these conditions has failed then limb (a) cannot be used and any calculation
work solely looks at (b). Ie no calculation work is ever done as to what the rules imply.
What consequential call is there to element (b) of the definition of relevant percentage?
Our reading is that (b) in the definition of relevant percentage applies if and only if (a) does not apply, because
of the word “otherwise”. The different interpretations noted above would then call (b) in two different ways.
•
Interpretation A can be restated as “if there was a provision in the rules in December 2010 that satisfied (a),
then (a) applies forever by reference to that provision”. This would mean (b) is never called.
•
Under Interpretation B, (a) could cease to be called, and (b) would then automatically be looked to.
Examples to show possible outcomes under the Interpretations
Say the rules at 9 December 2010 specified: 5% pa revaluation
or
a formula leading to an increase of 5% in the tax year in question
The table below analyses possible combinations of CPI (for the year up to September in the previous tax year)
and actual assessed increases in the value of rights, and looks at whether benefit accrual would be deemed to
take place in those circumstances, and hence whether Fixed Protection would be lost. To some extent it is an
artificial example, but it illustrates the real life impact of the possible different interpretations.
Actual
Actual grant after a rule
Interpretation A
CPI
change
3%
4%
No benefit accrual
Benefit accrual
(as the new rate specified
(because benchmark is still 5%)
(because (a) no longer
under the rules)
Interpretation B
applies, and grant is higher
than CPI
3%
4%
As above
(under a discretion)
(the fact that the new revaluation
As above
is granted by discretion is
Page 3
irrelevant)
6%
6%
Benefit accrual
No benefit accrual
(because benchmark is still 5% -
(because (a) no longer applies
even though the rules have
and grant is no higher than
changed, and the grant is no more
CPI
than CPI)
A third interpretation (C)?
We wonder if there may be yet a third reading, or at least a policy intent different from either (A) or (B): that
Fixed Protection benefit accrual does not occur so long as increases in any tax year is less than the greater of:
(a) The increase that would have applied based on the scheme rules in force on 9 December 2010, even if
the scheme’s current rules are different; and
(b) The increase in the CPI over the appropriate period.
Although this reading is hard to see given the specific word “otherwise”. Under this interpretation, none of the
scenarios above would give rise to benefit accrual.
Qualification by status
In all the interpretations, we note that, if there is a condition attaching to the provision in (a) - such as being a
deferred pensioner or in a particular category – then (a) applies in the test for benefit accrual only while the
condition is satisfied (see Section 8 of Newsletter 50).
(We note a member may go through more than one status where (a) might be called upon.)
What if a change is made partway through the tax year?
A further point of detail that needs addressing but is ignored in this letter is that of changes part way through a
tax year. These could be for example:
§
A change to the rules that specify a rate
This could be a change with immediate impact in the same tax year; or in such a way that the first
changed rate that applies is one in the next tax year (eg a rule change in October impacts revaluations
that are granted each May)
§
A change to a member’s status (eg a member who is active at 6 April and has no specified rate; but
then opts out to deferred pension status and acquires a specified rate).
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2.
Annual Allowance
We do not know whether the policy intent was that the “relevant percentage” aspects of the AA
deferred member carve out and the Fixed Protection relevant benefit test was that they should
work as similarly to each other as is practical (other than in specific areas of differences).
A corresponding pair of questions arises in relation to the operation of the so-called deferred member carve out
for Annual Allowance purposes. Is the interpretation that applies for Annual Allowance purposes in relation to
rule changes, interpretation A or B or C? Does the reference in (a) of the definition of relevant percentage to
“includes provision” solely mean “includes provision at [14 October 2010]” with no regard to rule changes
thereafter; or does it mean “still includes the provision that was the provision in the rules at [14 October]”.
Overall, is the intention that the answer to this question should be the same for AA and FP or different?
We suspect that the use of “throughout” in the definition for Annual Allowance has led readers to assume
interpretation (B) (arguably the lack of “throughout” in the corresponding definition for Fixed Protection purposes
has led readers towards Interpretation A in that case).
It is worth noting that RPSM06107220 and RPSM06107230 which relate to Annual Allowance states ‘One of the
conditions for the deferred member carve out in relation to an arrangement is that the member’s rights do not
increase by more than CPI or, if greater, the ‘relevant percentage’. This might suggest interpretation (C) but
does not seem to be in line with the legislation.
There are of course other very specific differences between the detailed operations of the Fixed Protection
benefit accrual test and Annual Allowance deferred member carve out. We summarise some of these in
Appendix 3 for completeness but this letter is not really trying to explore these points.
We look forward to your confirmation, in relation to each of Fixed Protection and Annual Allowance:
•
whether you consider that the correct interpretation of the legislation as it stands is Interpretation A, B
or C (or some other); and
•
the circumstances in which the CPI limb of the definition will apply.
It would be helpful to know if any amendments are proposed to change the law (possibly retrospectively) to
clarify these points, or to make the tests more consistent between Fixed Protection and Annual Allowance; or
for any other reason.
We would be happy to discuss this with you.
Yours sincerely
Karen Goldschmidt FIA (chair) and Mike Richardson FIA
For the ACA Pensions Taxation Committee
karen.goldschmidt@lcp.uk.com
Page 5
Appendix 1
Annual Allowance
Finance Act 2004, Section 234
(5B)
The pension input amount in respect of the arrangement is nil if—
(a)
the individual is a deferred member of the pension scheme under which it is an arrangement (or
would be if it were the only arrangement under the pension scheme relating to the individual)
throughout the pension input period or is (or would be) such a deferred member for part of the
pension input period and a pensioner member for the rest of it, and
(b)
the value of the relevant rights of the individual does not increase during the pension input period
by more than the relevant percentage.
(5C)
In this section –
“the relevant percentage” —
(a)
where throughout the pension input period the arrangement (or a predecessor
arrangement) includes provision for the value of the relevant rights of the individual to
increase at an annual rate specified in the rules of the pension scheme (or a predecessor
registered pension scheme) on 14 October 2010, that percentage, and
(b)
otherwise, the percentage by which the consumer prices index for a month falling within
the pension input period and nominated by the scheme administrator is higher than it was
for the same month in the previous period of 12 months (or nil per cent if it is not higher);
“specified”, in relation to an annual rate, means specified as a percentage figure or as a percentage
produced by movement in an index (or a combination of the two) but does not include a percentage
produced by the exercise of a discretion by any person.
Fixed Protection
Finance Act 2011, Schedule 18 paragraph 14
(12)
Increases in the value of the individual’s rights under an arrangement are to be ignored for the
purposes of sub-paragraph (5)(b) or (c)(ii) if in no tax year do they exceed the relevant percentage.
(13)
The relevant percentage, in relation to a tax year, means—
(a)
where the arrangement (or a predecessor arrangement) includes provision for the value of the
rights of the individual to increase during the tax year at an annual rate specified in the rules of
the pension scheme (or a predecessor registered pension scheme) on 9 December 2010, that
percentage (or, where more than one arrangement does so the higher or highest of the
percentages so specified), and
(b)
otherwise, the percentage by which the consumer prices index for the month of September in the
previous tax year is higher than it was for the same month in the period of 12 months (or nil per
cent if it is not higher).
Page 6
Appendix 2
Comparison of wording
Annual Allowance
Fixed Protection
The pension input amount in respect of the arrangement is nil
if
Increases in the value of the individual’s rights under an
arrangement are to be ignored for the purposes of subparagraph (5)(b) or (c)(ii) if
the individual is a deferred member of the pension scheme
under which it is an arrangement throughout the pension
input period ..... and
the value of the relevant rights of the individual does not
increase during the pension input period by more than the
relevant percentage.
in no tax year do they exceed the relevant percentage.
“Relevant percentage” – where
The relevant percentage,
in relation to a tax year, means—
throughout
the pension input period
the arrangement (or a predecessor arrangement)
where the arrangement (or a predecessor arrangement)
includes provision for the value of the
includes provision for the value of the
relevant*
rights of the individual to increase
rights of the individual to increase
during the tax year
at an annual rate specified in the rules of the pension
scheme (or a predecessor registered pension scheme) on 14
October 2010, that percentage
at an annual rate specified in the rules of the pension
scheme (or a predecessor registered pension scheme) on
9 December 2010, that percentage
(or, where more than one arrangement does so the higher or
highest of the percentages so specified)
and otherwise
and otherwise
the percentage by which the consumer prices index
the percentage by which the consumer prices index
for a month falling within the pension input period and
nominated by the scheme administrator
for the month of September in the previous tax year
is higher than it was for the same month in the previous
period of 12 months (or nil per cent if it is not higher).
is higher than it was for the same month in the period of 12
months (or nil per cent if it is not higher).
… ”the relevant rights of the individual" means rights of the
individual under the arrangement, other than any rights to a
guaranteed minimum pension; … “"guaranteed minimum
pension" has the meaning given by(a)section 8(2) of the Pension Schemes Act 1993, or
(b)section 4(2) of the Pension Schemes (Northern Ireland)
Act 1993;
…"specified", in relation to an annual rate, means specified
as a percentage figure or as a percentage produced by
movement in an index (or a combination of the two) but does
not include a percentage produced by the exercise of a
discretion by any person.
No explicit definition of “specified”
Page 7
Appendix 3
The following lists some of the very specific differences between the detailed operations of the Fixed Protection
benefit accrual test and Annual Allowance deferred member carve out. These are set out for completeness but
this letter is not really trying to explore these points.
§
The consequence of not satisfying the “relevant percentage” for a period: If the relevant
percentage is exceeded for the AA test in a particular pension input period so that the carve out does
not apply for that PIP (and the calculations fall back to those specified…) - for example if an additional
increase is granted on a discretionary basis in one PIP, the carve out may apply for a subsequent PIP
depending on the circumstances of the case; but if benefit accrual for FP applies in any tax year, then
fixed protection is permanently lost.
§
Whether the test has to be met continuously throughout the measurement period: The
annual allowance (“AA”) deferred member carve out test effectively is a test at the end of each PIP: (if
there is a specified rate and Interpretation B applies, then the relevant provision for (a) has to have
been in place and remained in place until then; and if (b) applies, a calculation has to be done of the
change between the closing and opening value of the PIP. By contrast; your guidance in Newsletter
50 indicates that FP benefit accrual test effectively involves an “anchoring” at each 5 April, with a
continuous test through the rest of the tax year; with FP lost from the instant of the failure.
§
Member status: the DMCO applies in a PIP if the individual is a “deferred member” (tax law
definition) throughout the PIP (or a deferred member for part of the PIP and a pensioner member
thereafter). The FP benefit accrual test operates whether or not the individual is a deferred member,
although there is an indirect relevance of status if limb (a) of the relevant percentage is contingent on
being/not being a deferred member
§
Treatment of GMP revaluation: the DMCO (whether via route (a) or (b)) excludes statutory GMP
benefits and their revaluation from the test (although if the test is failed then they are taken into
account for the purposes of the pension input amount); whereas the FP benefit accrual test implicitly
includes the GMP and its revaluations in the provisions.
§
The choice of CPI measure: The AA “deferred member carve out” has an additional stage, between a
stage relating to a “specified rate”, and the stage of fall-back to there being no special terms and the
normal full pension input amount calculations applying (including the specific inflation offset using CPI
for the year to September preceding the tax year). This additional stage allows nil PIA status to be
justified via a test of pension rights excluding GMPs and their revaluation, offsetting inflation using a
choice of annual CPI increases: typically a choice from 12 or 13 different CPI figures.
Page 8