There are two primary methods through which employers can seek tax relief on employee pension contributions.
These methods are commonly known as:
- Net Pay
- Relief at Source -within systems and processes used to contact HMRC this is also referred to as “contributions that are not paid under a net pay arrangement” or “not net pay”
Under the net pay arrangement, the employer deducts the pension contribution for which tax relief is due, directly from the employee’s gross income before implementing PAYE. As a result, the employee receives tax relief at their marginal income tax rate without the need to submit an additional claim.
Relief at Source (Not Net Pay)
The employer deducts an amount from the employee’s net pay (after accounting for tax and National Insurance deductions) equivalent to the pension contribution, net of basic rate tax relief. The pension scheme provider, in turn, claims the basic rate tax equivalent from HMRC Pension Scheme Services (PSS) and tops up the individual’s pension fund with this claimed amount. In “not net pay” arrangements, the individual may need to claim any higher or additional rate tax relief from HMRC through their tax code or Self Assessment.
To illustrate, using English tax rates, an individual wanting to make a pension contribution eligible for relief worth £100 effectively contributes £80 through the employer’s deduction from their net pay. This £80 is transferred by the employer to the pension scheme provider, which subsequently claims the due basic rate tax relief of £20 from HMRC PSS, adding it to the individual’s pension pot.
It’s worth noting that, since 2006, individuals do not have the option to select their preferred tax relief method; the default option for all new registered pension schemes has been relief at source. However, employers can choose to implement the net pay method when setting up a new pension scheme, provided the scheme meets specific conditions. Once registered, the tax relief method is set.
HMRC have noticed some common mistakes among employers, possibly stemming from the terminology associated with each approach:
- When an employer mistakenly reports a “not net pay” scheme as a net pay scheme through Real Time Information (RTI) in the data fields. This results in incorrect tax relief allocation through payroll, in addition to the correct tax relief offered by the pension scheme provider and HMRC PSS. Any excess relief provided becomes an employer payroll error, and the employer is held responsible for the under-deducted tax, which must be remitted to HMRC.
- Employers reporting pension contributions as net pay via RTI should verify the registration of their scheme with the scheme provider. If contributions have been inaccurately reported through RTI, corrections should be made promptly. Additionally, any identified errors from previous periods should be reported through the HMRC digital disclosure facility.
For further guidance on registered pension schemes, please contact a member of the CB Reid team.