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Kevin Pither examines the impact of Self Assessment on occupational pension schemes

The implementation of Self Assessment and the treatment of the information received as a result, is seen by many as clear evidence of the Inland Revenue’s increased interest in the activities of occupational pension schemes and the potential tax revenue they represent.

Self assessment

In September 1997 the Pension Schemes Office (PSO) announced in Update No.30 that self-administered pension schemes would be brought within the Self Assessment system. Tax relief for pension schemes amounted to approximately £10 billion during the fiscal year 1996/97 and closer monitoring of the relief was considered essential. In 1996/97, the first year of Self Assessment, returns were issued to the trustees of those schemes for which there was likely to be a tax charge during the year. In 1997/98 the intention was to issue a tax return to approximately 20 per cent of all schemes to test the operating systems. For the fiscal year 1998/99 the Inland Revenue intended to issue returns to all approved self-administered schemes.

The responsibility for completing the forms lies with the trustees of the scheme, unlike the reporting of chargeable events which rests with the “administrator”, the person identified by Section 611AA of the Income and Corporation Taxes Act 1988.

All self-administered schemes must complete a return even if there is no tax liability to report. Failure to complete a return by 31 January 2000 is likely to lead to sanctions being imposed by the Revenue. It is anticipated that trustees will be fined for a return which misses the deadline. However, a repeated failure to make returns could result in withdrawal of approval. In view of the potential sanctions, trustees should contact their local inspector of taxes if they have not yet received the tax return, form SA970. The purpose of the return is to ensure that all repayments have been made correctly and that the scheme’s tax liability has been correctly notified and paid.

The introduction of Self Assessment for pension schemes is not really surprising. However, the issuing of the returns has highlighted two areas where the Revenue’s intervention was less predictable. The two activities which the Revenue have considered to be unacceptable exploitation of the available tax reliefs are the payment of sub-underwriting commissions and share buy-backs. Trustees will need to disclose their involvement in these activities on their tax returns.

Sub-underwriting commissions

Sub-underwriting is the practice whereby the unsold shares available from a flotation or rights issue are guaranteed to be purchased by an underwriter. The underwriter in turn arranges for a sub-underwriter to acquire a given percentage of the shares. The sub-underwriter is paid a commission which is retained whether or not the share offer is fully subscribed. This income is not investment income and may, therefore, be considered to be trading income and accordingly taxable. However, there is an exemption for sub-underwriting commissions under Section 592(3) of the Income and Corporation Taxes Act 1988 if the Revenue are satisfied that the activity does not amount to trading.

This issue came to prominence following the case of British Telecom Pension Scheme Trustees v Clark. In this case the Special Commissioners had ruled that the trustees’ involvement in sub-underwriting did not amount to trading. They considered that if it was unclear whether an activity amounted to trading, the trustees’ motives in engaging in the sub-underwriting should be examined. In this case the Special Commissioners decided there was no intention to trade, make a profit or solicit sub-underwriting.

The Revenue appealed, arguing that the Special Commissioners’ reasoning in considering the trustees’ motive to establish whether they had entered into trading was flawed. The Court agreed and it was held that the activity of sub-underwriting had all the characteristics of trading, there was nothing equivocal about it and, therefore, the trustees were trading. It was legally irrelevant whether the trustees analysed their activity as generating trading or investment income.

We understand this case is being appealed, but in the meantime it seems that sub-underwriting with any degree of frequency should be approached with extreme caution and trustees should be aware that such activities may attract a 34% tax charge. Trustees may need to check with their investment advisers whether they have been involved in this kind of activity.

Share buy-backs

The Self Assessment form also queries schemes’ involvement in share buy-backs. Until recently, a pension scheme which sold shares back to the company which issued them (rather than selling them in the open market) could treat the transaction as a dividend payment and claim a tax credit on top of the purchase price. This credit can no longer be claimed, but the Inland Revenue is still investigating a large number of historic cases.

The Revenue began enquiring into share buy-backs two years ago. A request would be made for details of the acquisition and disposal of the buy-back shares together with an account of the history of shareholding in the company concerned during the 12 months before and after the buy-back. This would allow the Revenue to determine which tax credits received by the scheme could be challenged.

The Revenue consider that share buy-backs by pension schemes can amount to tax avoidance under Section 703 of the Income and Corporation Taxes Act 1988. A tax charge will therefore be imposed on such transactions unless the scheme can demonstrate that they were carried out “... for bona fide commercial reasons or in the ordinary course of making or managing investments, and that none of them had as their main object, or one of their main objects, to enable tax advantages to be obtained...”

Determining what “bona fide commercial reasons” are is not an exact science. If a scheme is able to demonstrate that it had a policy of holding shares in the companies concerned or in a particular sector of the market, or if the trustees can prove that shares were acquired before a buy-back was announced it is more difficult for the Revenue to argue that the purchase was not made in the ordinary course of managing investments. However, in order to be able to provide that information fund managers are spending a considerable amount of time and resources investigating transactions which took place several years ago, so even if you are safe there may be an administrative cost.

Despite persistent lobbying by the NAPF and various other organisations, Patricia Hewitt, the former treasury minister, was not prepared to discuss this issue. Although the Inland Revenue has not supported the use of a test case, it is likely that a number of cases will be referred to the Special Commissioners in the near future. They should help to clarify the basis on which the Inland Revenue can challenge the tax credits. However, it seems likely that no matter what the outcome, the issue will continue to be argued in view of the estimated £1.5billion in tax credits which are at stake.

When the dust settles on the issues of sub-underwriting commissions and share buy-backs it is evident that Self Assessment will make it easier for pension schemes to be targeted in the Revenue’s continued fight against anti-avoidance.