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Employment Income Manual

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Employer-financed retirement benefits schemes: overseas relief examples

 

The examples on this page are simplified to demonstrate the application of different pieces of legislation according to situation and time. They are not intended to demonstrate how every last detail of the conditions required for the various exemptions to operate is satisfied in these fictional cases.

Example 1 – Lump sum paid before 6 April 2011

Example 2 - Lump sum paid on or after 6 April 2011 by employer directly

Example 3 – Lump sum paid on or after 6 April 2011 and before 5 February 2014, where rights accrued before 6 April 2011

Example 4 – Lump sum paid on or after 5 February 2014, where rights accrued before 6 April 2011

Example 5 – Lump sum paid on or after 6 April 2011, where rights accrued after 5 April 2011

Example 6 – Combined example – service before and after 6 April 2011

Example 1 – Lump sum paid before 6 April 2011

For guidance on ESC A10 see EIM15082 and subsequent guidance.

Extra-Statutory Concession A10 – full exemption example

In 2010 an employee retired from employment with a foreign company after 20 years’ service.

Suppose the service in the first 15 years counted as foreign service (see the definition at EIM13690) whereas that of the last 5 did not.

On retirement in 2010, the scheme paid the employee a lump sum of £100,000.

ESC A10 applied. Not less than 75% of service in the employment was foreign service (15/20 = 75%) so test (a) in EIM15083 was met. Consequently the lump sum was fully exempt from income tax.

Extra-Statutory Concession A10 – partial exemption example

In 2010 an employee retired from employment with a foreign company after 15 years’ service.

Suppose the service of the first 6 years counted as foreign service (see the definition at EIM13690) whereas that of the last 9 did not.

On retirement in 2010, the scheme paid the employee a lump sum of £90,000.

ESC A10 applied. The foreign service did not meet any of the three tests in EIM15083 but partial exemption was available. Following EIM15083, the amount of the £90,000 lump sum that was to be charged was reduced by the same proportion as the foreign service bore to the employee’s total service in that employment, that is 6 years out of 15 years.

(6/15) x £90,000 = £36,000 reduction

£90,000 – £36,000 = £54,000 left chargeable under Section 394 ITEPA 2003.

Example 2 – Lump sum paid on or after 6 April 2011 by employer directly

Payment before 5 February 2014

An employee retired from employment with a foreign company in 2012 after 15 years’ service.  On retirement in 2012, the employer paid a lump sum of £90,000 under the scheme.

Part 7A ITEPA 2003 took effect from 6 April 2011 but does not apply to the direct provision of benefits by an employer. A lump sum paid on retirement by the employer is a relevant benefit subject to Section 394 ITEPA 2003.

However, suppose the service of the first 6 years counted as foreign service (see the definition at EIM13690) whereas that of the last 9 did not. This means that there can be a foreign service exemption. 

At the time of the payment ESC A10 still applied. The ‘foreign service’ did not meet any of the three tests in EIM15083 but partial exemption was available. Following EIM15083, the amount of the £90,000 lump sum that was to be charged was reduced by the same proportion as the foreign service bore to the employee’s total service in that employment, that is 6 years out of 15 years.

(6/15) x £90,000 = £36,000 reduction

£90,000 – £36,000 = £54,000 left chargeable under Section 394 ITEPA 2003.

Payment after on or after 5 February 2014

An employee retires from employment with a foreign company in 2015 after 15 years’ service. On retirement in 2015, the employer pays a lump sum of £90,000 under the scheme.

Part 7A does not apply to direct provision of benefits by an employer. A lump sum paid on retirement by the employer is a relevant benefit subject to Section 394.

However, suppose the service of the first 6 years counted as foreign service (see the definition at EIM13690) whereas that of the last 9 did not. This means that there can be a foreign service exemption. By the time of the payment ESC A10 no longer operates and has been replaced by Section 395B ITEPA 2003.

The foreign service did not meet any of the three tests for full exemption in EIM15325 but partial exemption is available. The amount of the £90,000 lump sum, which without any exemption would be fully charged under Section 394, is reduced by the same proportion as the foreign service bears to the employee’s total service in that employment, that is 6 years out of 15 years.

(6/15) x £90,000 = £36,000 reduction

£90,000 – £36,000 = £54,000 left chargeable under Section 394 ITEPA 2003.

Example 3 – Lump sum paid on or after 6 April 2011 and before 5 February 2014, where rights accrued before 6 April 2011

This example concerns lump sums paid by an EFRBS that is a third-party arrangement. For lump sums paid directly by the employer see Example 2 above.

An employee worked for an employer between 1 January 2007 and 31 December 2009.  Her service was fully outside the UK while non-UK resident. In August 2013 she reached her retirement age under the EFRBS and took benefits following retirement in one lump sum that same month.

During her two years of service the employer contributed £50,000 pa, totalling £100,000.  With investment returns this amounted to a fund of £120,000 by the time of retirement.

The employee’s right to the eventual lump sum had been in place before 6 April 2011 and Section 554W ITEPA 2003 applies to the entirety and there is therefore no charge via Part 7A. Any charge falls to be determined by Section 394 and ESC A10.

Because all of the service was foreign service full exemption applies under ESC A10. There is no income tax charge on the £120,000 lump sum.

Example 4 – Lump sum paid on or after 5 February 2014, where rights accrued before 6 April 2011

This example concerns lump sums paid by an EFRBS that is a third-party arrangement. For lump sums paid directly by the employer see Example 2 above.

An employee worked for an employer between 1 January 2007 and 31 December 2009.  His service was fully outside the UK while non-UK resident. In August 2014 he reached his retirement age under the EFRBS and took benefits following retirement in one lump sum that same month.

During the two years of service the employer contributed £50,000 p.a., totalling £100,000.  With investment returns this amounted to a fund of £120,000 by the time of retirement.

The employee’s right to the eventual lump sum had been in place before 6 April 2011 so Section 554W ITEPA 2003 applies to the entirety and there is therefore no charge via Part 7A. Any charge falls to be determined by Section 394 and Section 395B.

Because all of the service was foreign service full exemption applies under Section 395B.  There is no income tax charge on the £120,000 lump sum.

Example 5 – Lump sum paid on or after 6 April 2011, where rights accrued after 5 April 2011

This example concerns lump sums paid by an EFRBS that is a third-party arrangement. For lump sums paid directly by the employer see Example 2.

An employee started work for an employer on 6 April 2012 joining the employer’s EFRBS on the same day. Her service was outside the UK until 5 April 2015 when she returned to the UK. Her service ends on 5 April 2017. In each year of overseas service the employer contributes £10,000 and once the employee is back in the UK the employer contributes £5,000 each year. Following her retirement in 2020, the employee receives a lump sum of £48,000 from the EFRBS.

Each annual contribution is immediately followed by a relevant step under Section 554B chargeable to income tax via Section 554Z2 ITEPA 2003 as follows:

2012/13           £10,000 earmarked, fully mitigated by Section 554Z4 for overseas service. Amount chargeable via Section 554Z2 = £nil.

2013/14           £10,000 earmarked, fully mitigated by Section 554Z4 for overseas service.               Amount chargeable via Section 554Z2 = £nil.

2014/15           £10,000 earmarked, fully mitigated by Section 554Z4 for overseas service.               Amount chargeable via Section 554Z2 = £nil.

2015/16           £5,000 earmarked, not mitigated by Section 554Z4 because service is in the UK. Amount chargeable via Section 554Z2 = £5,000 at marginal rates.

2016/17           £5,000 earmarked, not mitigated by Section 554Z4 because service is in the UK. Amount chargeable via Section 554Z2 = £5,000 at marginal rates.

2020/21           £48,000 lump sum payment is a Section 554C relevant step apportioned by Section 554Z4 to 2/5ths = £19,200. A deduction of £10,000 is taken from this in respect of the amount already subject to charge in past years (2015/16 and 2016/17 – Section 554Z5). This leaves £9,200 subject to charge via Section 554Z2.

Example 6 – Combined example – service before and after 6 April 2011

Service:

On 6 April 2006 individual A starts working in the UK for a new employer B1. At the same time A becomes a member of B1’s gradually funded overseas-based EFRBS. No employee contributions are payable, only the employer contributes.

On 6 April 2010 A’s work moves overseas – serving B1’s subsidiary employer B2.

A retires on 5 April 2016 after 10 years’ service for B1 and B2, in the last 6 of which he was not UK resident and was not performing any duties in the UK.

Lump sums:

On retirement A receives a payment of £1m from the EFRBS in respect of the entire 10-year period of service during which he was a member of the scheme.

On top of this, B2 gives A an additional £100,000 as a retirement top-up lump sum, above the scheme benefit but in respect of the same entire 10-year period.

Part 7A

Please note this example does not mention any earlier relevant steps ,such as on the trustees’ earmarking of contributions within or in relation to the arrangement, and does not address any issues that would follow on from such earlier steps. This is purely to maintain the relative simplicity of the example.

£1m lump sum:

If there were no exceptions to the effect of Part 7A of ITEPA 2003, the whole £1m lump sum would simply count as employment income by virtue of Section 554Z2 when the payment was made (the payment being a relevant step under Section 554C).

However Section 554W provides an exception and how it applies in this example is outlined below.

Separately, because of the overseas service elements Section 554Z4 may reduce the amount of the chargeable payment.

Care must be taken in applying these two provisions (Section 554W and Section 554Z4) to consider which parts of the sums in question they should apply to and in what order.

£100,000 lump sum:

The £100,000 top-up payment by B2 is paid directly by the employer. This does not constitute a relevant step taken by a relevant third person so Part 7A does not apply to it.

Section 554W and accrual

6 April 2011 is a key date for the Section 554W exception. It asks how much of the lump sum right(s) accrued before that date.

Suppose in this example the facts regarding the main £1m lump sum show that:

  • £600,000 represents A’s pre-6 April 2011 lump sum rights under the funded EFRBS – that is for the first five years of the service being rewarded, and
  • £400,000 represents A’s post-5 April 2011 rights for the later block of five years.

The accrual split in this example reflects the reality that accrual is not always just a matter of dividing the lump sum by the number of years of service on each side of the key date.  The amounts accrued depend on when contributions were paid and the rights expressed historically under the rules of the scheme. The time when growth arises might not determine when the right to that growth accrued.

Because the £100,000 lump sum paid by B2 is not within Part 7A, we don’t need to consider the application of Section 554W to it.

Section 554Z4 and accrual

Section 554Z4 concerns how much of any lump sum was ‘for’ non-UK service when non-UK resident and how much of it was for anything outside that description. This apportions the benefit into two parts.

The concept of a benefit being ‘for’ a given period of service (mindful of the location of that service and the residence status of the individual at that time) includes retrospectively awarded lump sums (i.e. that is sums awarded only at or after the end of service). It recognises that the benefit is given for the entire length of service. See EIM45720 for more details of how Section 554Z4 works, including the need for a ‘just and reasonable’ apportionment between the two elements.

Section 554W before Section 554Z4

The last six years of service in this example are outside the UK so potentially within sight of Section 554Z4’s apportioning power. However, because the function of Section 554Z4 is to reduce the charge under Part 7A, if any portion of the lump sum is first excluded from charge under Part 7A (such as by Section 554W as explained below), then Section 554Z4 cannot begin to apply to the excluded portion as there is nothing in that portion to reduce. In other words we first need to consider the operation of Section 554W before Section 554Z4.

£1m lump sum:

It’s been established above that Section 554W is an exception to Part 7A charges (see EIM45640). This prevents the £600,000 portion of the lump sum accrued before 6 April 2011 being charged under Part 7A.

Only the later £400,000 portion is available to test under Section 554Z4. This portion was ‘for’ the tax years 2011/12 to 2015/16, for the whole of which period A was not UK resident and was working outside the UK. On that basis Section 554Z4 stops the entirety of the £400,000 from counting as employment income under Part 7A.

Whether or not Section 554Z4 could also cover the year 6 April 2010- 5 April 2011 (the first year of non-UK service) is academic because Section 554W already took that part out of charge.

There are consequently no Part 7A tax charges on the £1m lump sum. We already saw that Part 7A also did not apply to the £100,000 lump sum. However as the provision for both of the lump sum relevant benefits originates from the employer, we still have to consider Section 394:

Section 394

£1m lump sum:

£600,000 portion accrued before 6 April 2011

As noted above, Section 554W applies to the £600,000 portion of the lump sum because it accrued before 6 April 2011. This would therefore be chargeable as employment income under Section 394 were it not for the operation of Section 395B (see EIM15325).

This portion of the lump sum relates to the 5-year period 2006/07 to 2010/11, of which one year (2010/11) counted as foreign service. The foreign service does not meet any of the three tests for full exemption under Section 395B, but partial exemption is available. The amount that would be chargeable under Section 394 is reduced in the same proportion as the foreign service bears to A’s reckonable service, that is 1 year out of 5 years.

            (1/5) x £600,000 = £120,000 reduction

            £600,000 - £120,000 = £480,000 left chargeable under Section 394 ITEPA 2003

£400,000 portion accrued after 5 April 2011

As shown above, Section 554Z4 prevented the £400,000 portion from counting as employment income under Section 554Z2 (Part 7A). This £400,000 all counts as ‘other relevant income’ under Section 394(4C)(c), meaning that there is nothing of this portion left to tax under Section 394(1).

£100,000 lump sum:

As this is paid directly by the employer, rather than via a third party arrangement, it is not subject to Part 7A.

The reckonable service in relation to the £100,000 payment is the entire 10-year period to 5 April 2016. Section 395B gives a partial reduction in the amount counting as employment income under Section 394 for the later 6 years of foreign service as follows:

            (6/10) x £100,000 = £60,000 reduction

            £100,000 - £60,000 = £40,000 left chargeable

Putting the two elements together, the total amount counting as employment income is £480,000 + £40,000 = £520,000