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HMRC internal manual

Business Income Manual

Specific deductions: pension schemes: wholly & exclusively: cessation of a trade

S34(1) Income Tax (Trading and Other Income) Act 2005, S54(1) Corporation Tax Act 2009

Expenditure incurred for the purposes of going out of business, rather than for the purposes of carrying on the business fails the wholly and exclusively for the purposes of the trade test (see BIM38310 for further guidance on this principle).

However, the payment of a pension contribution is part of the normal costs of employing staff and the fact that it may have arisen on the cessation of a trade does not automatically mean it was made for non-trade purposes.

Contractual obligation to make contributions

Where an employer undertakes to provide employees with a pension as part of their employment package then the costs of meeting such an undertaking entered into for business purposes are incurred for the purpose of the trade (CIR v Cosmotron Manufacturing Co Ltd [1997] 70TC292, see BIM38315). Therefore, pension contributions made under such contractual obligations in the capacity of employer are deductible even if they arise on the cessation of the trade.

Where an employer makes a pension contribution arising from a contract of employment with its employees, the question of deductibility is not affected by the fact that the decision, or need, to make the contribution to the pension scheme is crystallised after:

  • the employees retire or leave the employer’s service;
  • the employer ceases to carry on the trade; or
  • the employer sells the trade or a part of the trade in which the employees work; or
  • the debt has crystallised under a statutory provision, such as S75 Pensions Act 1995 (PA 1995) (see BIM46045).

No contractual obligation to make contributions

Where the undertaking to provide a pension was not given to the employees as part of their employment package the cost may not be allowable. If the decision to make the contribution was for the purposes of going out of business or other non-trade purposes, the contribution will not be an allowable deduction. However it is often the case that the contribution, which represents a cost of employing staff, will have been made for no other reason than to preserve reputation and morale, in which case a deduction can be claimed.

Whether a pension contribution is allowable as a deduction depends on why the employer decided to make the contribution when it was not under a contractual obligation to do so.

In the case of CIR v Anglo Brewing Co Ltd [1925] 12TC803, the company decided to close down its business. In the past the company had granted pensions to employees on their retirement. The company promised to treat its present employees with equal generosity. The company therefore agreed pension amounts (which were later commuted for lump sums) and compensation payments.

The High Court took the view that the payments were made for the purpose of winding up the company and that no deduction was due for the pensions or the compensation. Rowlatt J explained that the payments were not made for the purpose of the trade because that would have required that the payments be for keeping the trade going. The company made the payments not to continue to trade but to cease trading; see BIM38310.

By contrast, in O’Keefe v Southport Printers Ltd [1984] 58TC88, the company was a member of a group the parent of which was Liverpool Daily Post & Echo Ltd. (LDPE). Southport‘s trade was unprofitable. Its directors recommended to LDPE that it should be closed down. It was clear that the unions would be unlikely to allow an orderly closure if only statutory and contractual obligations to employees were met.

Southport’s directors recommended to LDPE that it should pay a further £80,000 to Southport’s employees on closure to protect the businesses of the members of the group. LDPE accepted this recommendation. The High Court decision to allow a deduction for those payments may be contrasted to that in CIR v Anglo Brewing Co Ltd. The payment in Southport was to ensure orderly trading and not to close the business, see BIM38320.

Example 1: contractual obligations

A company decides to sell off its trading activities and concentrate on its property investment business. It operates a registered pension scheme for its employees, which has been underfunded for a number of years. Prior to selling its trading activities, it pays £75m into its pension scheme so that it is fully funded.

The obligation to make the payment to the pension scheme arose from the employees’ remuneration packages. It is a cost of carrying on the trade that crystallised at cessation. The contributions are paid wholly & exclusively for business purposes and are allowable for the period in which they were paid.

Example 2: no contractual obligations

A company sells its trade and ceases activity. In the final period before cessation the company makes a substantial payment into a registered pension scheme on behalf of a director. This pension scheme was not part of the director’s remuneration package.

You need to establish the facts of the case. The contribution may be disallowable as a cost of going out of business and so not wholly and exclusively for the purpose of carrying on the employer’s trade (see BIM38310).

Had this been a payment to a pension scheme that was part of the director’s remuneration package, then it would be allowable as it would simply be a business cost that crystallised at cessation.

Example 3: no contractual obligations

Company A decides to sell one of its trading divisions to an unconnected Company B. Three years after the sale, Company A learns that Company B has ceased trading and it is found that its pension scheme is underfunded. Company A has no legal obligations to the pension scheme but decides to pay an additional £5 million into it. It is established as fact that Company A does this solely because it wishes to reassure its existing employees that their pensions in Company A’s own pension scheme are safe.

Company A can make a deduction for the contribution for the period of payment as the purpose of making the payment was wholly and exclusively that of its existing trade. The Company chose to make the payment in order to reassure its existing staff.

Example 4: contractual obligations

Company A sold its toy manufacturing operations to a third party. The changes were not of a scale or nature that meant that Company A’s existing trade ceased (see BIM80595). The new owner took over responsibility for the pension liabilities of the toy manufacturing operations, but went into administration/liquidation within 12 months. In accordance with the sale and purchase agreement provisions, the pension liability for Company A’s former employees transferred back to company A.

Company A no longer has any toy manufacturing operations but is continuing to trade. It is established as fact that the trade is the same trade as was carried on before the disposal of the toy manufacturing operation.

Company A can make a deduction for the contribution as the purpose of making the payment was wholly and exclusively for the purpose of its existing trade.

Example 5: nature of contractual obligations

A company decides to close its trading activities and concentrate on its property investment business. It operates a pension scheme for its employees, which was fully funded at cessation. Three years after the cessation, following a fall in the value of its investments, the pension scheme is underfunded. The company pays an additional £5m into its pension scheme so that it is again fully funded.

The question is the purpose of the expenditure. Why has the company made the payment?

If the payment is to cover a liability under S75 PA 1995 then it is treated as being paid on the last day of trading, see BIM46010.

However if that rule does not apply, but the company made the payment to honour a commitment or obligation entered into as part of the trade, then it is post cessation expenditure of the trade and relief would be under post cessation receipts legislation, see BIM90080.

If the contribution is not post cessation trading expenditure, it may be an allowable expense of the property business, for example if it was paid to reassure its existing employees that their pensions in Company A’s pension scheme are safe.