How to reduce corporation tax using director's pension contributions

The corporate tax rate, i.e., corporation tax, is increasing to 25% (Corporation Tax - CT). This increase affects all companies with profits exceeding £50,000. Many businesses will feel this acutely. How can you reduce the amount HMRC will take?

Contributions to Pension Plan for directors - a way to reduce CT

Corporation Tax is proportionally allocated among partners (if the company has any). One excellent way to reduce this tax is through pension contributions for company directors. These are exempt from both income tax and National Insurance contributions (National Insurance - NI).

Contributions to directors' pension plans are subject to several restrictions.

Contributions should be made for controlling directors

HMRC may disallow substantial pension contributions if they are made for directors who do not have control over the company. This is because pension contributions are considered allowable business expenses, and therefore, like other allowable expenses, they should wholly and excusively serve the purposes of that business. For directors who do not control the company's operations, these purposes are debatable, which may lead to the tax authority disallowing such a deduction.

Consider spreading contributions over time

It's important to remember that only contributions paid within a given accounting period can be deducted. In other words, contributions to registered pension schemes are allowed in the period they are made, regardless of the accounting period in which they are reported. However, before making these payments, the company should check what contribution amount will be most tax-efficient.

It should also be noted that if contributions exceed £500,000 and are more than 210% of the previous year's contribution, the relief may be significantly delayed, as it is spread over instalments. If the excess is between £500,000 and £1,000,000, it is spread over 2 years; if between £1,000,000 and £2,000,000 - over 3 years; and above that amount, over 4 years.

The allowed annual tax-free contribution amount (Annual Allowance - AA)

From April 2023, the tax-free annual allowance for contributions will be £60,000 (up to April 2023 - £40,000); however, this also includes contributions that the director pays themselves. If contributions exceed the permitted tax-free amount, you should check if the AA allowance has been fully utilized in the 3 previous tax years – if not, the excess can be 'carried forward' to those years.

It's also worth noting that the lifetime allowance for funds accumulated in pension accounts has been completely abolished. Until April this year, it was £1,073,000, and sums above this amount were subject to taxation; from April 2023, it will no longer exist.

How pension contributions reduce corporation tax

The impact of directors' pension contributions on CT is illustrated in the table below:

As the above shows, contributions to Pension Plan for directors can significantly reduce the tax liability, so it is worth taking advantage of this opportunity if the company's finances allow.