MTT21220 - Calculating the effective tax rate: Adjusted profits: Pension fund expense
There are two main types of pension schemes, defined contribution schemes and defined benefit schemes.
With both defined contribution and defined benefit schemes, the employer and employee typically contribute a percentage of an employee’s salary into the pension scheme each year. The difference between the two schemes is the value of the benefit that is received on retirement. With a defined contribution scheme, the benefit on retirement is variable – the value of the pension pot can go up or down depending on how the investments perform. With a defined benefit scheme, the benefit on retirement is fixed – the pension provider guarantees a certain amount each year on retirement.
Defined benefit pension schemes must be kept sufficiently funded by the groups using them, to ensure that the scheme has the necessary funds to pay the defined benefits to its beneficiaries. Payments to and from these funds are accounted for differently under different accounting standards.
For both defined benefit and defined contribution schemes, an adjustment is required in some cases to the underlying profits of a member, to ensure that the adjusted profits reflect the actual contributions made to, and receipts from, a pension fund in the accounting period.
The adjustment is set out in [update with reference to current Finance Bill when enacted]
Accounting treatment of defined benefit pension schemes
Groups will generally have a single sponsoring entity which is responsible for maintaining funding of the pension scheme.
Where a defined benefit scheme is underfunded, a liability and expenses will accrue in the sponsoring entity’s accounts. Conversely, if the defined benefit scheme is overfunded, an asset and income will accrue. Accounting standards typically recognise the income or expenses in the profit or loss statement or other comprehensive income (OCI). Amounts recognised in OCI are outside of Pillar 2 underlying profits (see MTT21010). The timing and circumstances of recycling of the income and expenses from OCI to the profit and loss statement vary.
Where there are no actual pension contributions or receipts in a period, the effect of the adjustment is to reverse out any expense or income which has been recognised in the member’s underlying profits.
Where contributions to or receipts from a pension fund have actually been paid or received in the period, these must be reflected in the adjusted profits. An adjustment will be required if the amount is not reflected in the underlying profits.
Pension adjustment
To determine the amount of the adjustment:
- take the amount of income (expressed as a positive) or expense (expressed as a negative) arising directly in respect of a pension fund, as reflected in the member’s underlying profits.
- add the contributions made to the pension fund by the member in the period.
- subtract any receipts from the pension fund in the period.
The result is to be subtracted from the underlying profits of the member. If the result is a positive figure, this will result in a decrease to the underlying profits. If it is a negative figure, there will be an increase to the underlying profits.
Whether income or expense has arisen directly in respect of a pension fund
Groups will generally have a single sponsoring entity which is responsible for maintaining funding of the pension scheme. Where this is the case, only the sponsoring entity, in its underlying profits, can have income or expense arising directly in respect of the fund, and only that entity will make contributions to or receive amounts from the fund.
However, where employees of other group companies are also beneficiaries of the fund, those other companies will typically make payments to the sponsoring entity, to the extent that the fund needs topping-up for the benefit of their employees. (Or, in the less likely situation of the fund being overfunded and releasing cash to the sponsoring employer, it can receive amounts from the sponsoring employer.)
These intra-group payments will be reflected in the underlying profits appropriately with no need for an adjustment. They will not be considered as “contributions to” or “receipts from” a pension fund, and the income and expense recorded in the underlying profits will not be considered to have arisen “directly in respect of a pension fund”, as they have arisen only indirectly in respect of the fund.
This treatment would apply regardless of whether the scheme that is being administered by the sponsoring entity is a defined benefit scheme or a defined contribution scheme.
Example 1
A Ltd and B Ltd are members of different groups. They each use different accounting standards.
They each contribute £10m to a defined benefit pension scheme in the accounting period. Neither company has receipts from a pension fund.
A £10m pension expense is reflected in the profit and loss account of A Ltd in accordance with its accounting standard.
The pension adjustment for A Ltd is determined as follows:
|
Description |
Amount (£) |
|---|---|
|
Expense included in underlying profits |
-10m |
|
Contributions made in period |
+10m |
|
Receipts from the fund in period |
-0m |
|
Total pension adjustment |
0m |
There will be no adjustment to the underlying profits for A Ltd. The contributions made by A Ltd in the accounting period are already reflected in its underlying profits, so there is no need for any adjustment.
The pension adjustment for B Ltd is determined as follows:
|
Description |
Amount (£) |
|---|---|
|
Expense included in underlying profits |
0m |
|
Contributions made in period |
+10m |
|
Receipts from the fund in period |
-0m |
|
Total pension adjustment |
+10m |
The adjustment amount is positive, so £10m must be deducted from the underlying profits of B Ltd when calculating its adjusted profits. This ensures that the pension fund contribution for B Ltd is treated for MTT purposes as it would have been treated had its accounting standard allowed the contribution as a deduction in the profit and loss account.
Example 2
C Ltd and D Ltd are members of the same group. C Ltd administers a defined contribution pension scheme fund on behalf of the group.
C Ltd accrues a pension expense in its profit and loss account of £10m in respect of the pension scheme in an accounting period. However, C Ltd only makes a payment of £8m to the pension in that period.
D Ltd is a trading entity, and a number of the employees to which the pension cost in C Ltd relates actually work for D Ltd. Consequently, D Ltd makes an intercompany payment of £5m to C Ltd in respect of the pension cost. This amount is accrued and paid in the accounting period.
The adjustment to underlying profit for the pension fund expense in both entities would be calculated as follows:
|
Description |
Amount (£) |
|---|---|
|
Expense included in underlying profits |
-10m |
|
Contributions made in period |
+8m |
|
Receipts from the fund in period |
-0m |
|
Total pension adjustment |
-2m |
The adjustment amount is negative, so C Ltd must increase its underlying profits by £2m. This aligns the expense in the underlying profits with the amount actually contributed.
C Ltd’s £5m intercompany receipt from D Ltd would not meet the definition of income that has arisen directly in respect of a pension fund, and therefore it is not to be reflected in the computation of the total pension adjustment for C Ltd. The timing of the intercompany receipt is not relevant.
The payment by D Ltd is not considered to be a contribution made to a pension fund. Section 147 is therefore not applicable to D Ltd. Only the sponsoring company (which is C Ltd in this example) contributes to and receives amounts from the pension fund.