HMRC recently published the second instalment of its guidance on the tax consequences of implementing GMP equalisation. While the guidance provides clarity and offers solutions in some areas, it also identifies some potential problems for schemes, in particular, raising the prospect of trivial commutation lump sums that have previously been paid being treated as unauthorised payments in some instances.
Like the first instalment, this latest guidance only relates to adjustments where the reason for the adjustment is solely related to GMP equalisation. It does not cover other benefit adjustments, if any, which occur at the same time or as a result of GMP conversion. HMRC also makes clear that it does not intend to publish any specific guidance on the tax issues associated with GMP conversion, as the issues are complex and have wide-ranging implications. This is disappointing given the uncertainty surrounding this and given the number of schemes considering this option.
In addition to HMRC’s guidance, the GMP equalisation working group has also recently published its guidance on the options for addressing the data issues that can arise in the context of implementing GMP equalisation. You can read our summary of that here.
Following the decision of the High Court in the Lloyds Bank case in October 2018, trustees and sponsors of most DB schemes are in the process of deciding how best to implement GMP equalisation in the context of their scheme. One of the key factors in settling upon a preferred approach is considering the potential tax implications associated with the various options.
In February, HMRC issued the first instalment of its guidance on the tax implications of implementing GMP equalisation, which focused, in particular, on issues relating to the annual and lifetime allowances. The latest instalment supplements this and sets out HMRC’s views on some of the tax issues associated with past and future lump sum payments, including top-up payments that may become due to some members.
1. Previous lump sum payments
In the context of lump sum payments that have already been paid, the guidance considers the following issues:
1.1 Extinguishing the benefits under the scheme
A payment condition that must be met in order for a number of lump sum payments made by registered pension schemes to be treated as authorised payments, is that the lump sum must “extinguish the member’s (or dependent’s) right to benefits under the scheme”. This requirement applies in relation to winding-up lump sums, serious ill health lump sums, trivial commutation lump sums and small lump sums, among others.
There has been uncertainty over the tax consequences, where a further entitlement is identified in respect of a member who has previously received a lump sum which is subject to this requirement, as a result of a scheme implementing GMP equalisation. On this point HMRC’s guidance is helpful, as it confirms that a historic lump sum payment “will not stop being an authorised payment purely because, due to GMP equalisation, further entitlement is later identified that the scheme administrator could not reasonably have known about at the time of the lump sum payment”.
1.2 Payment limits
The payment conditions for the following types of lump sum include a limit on the amount of the payment:
- small lump sums
- winding-up lump sum
- trivial commutation lump sum death benefit, and
- winding-up lump sum death benefit.
The exact limit depends on the date the lump sum was paid. For example, in relation to small lump sums the limit was £2,000 for lump sums paid before 27 March 2014 and £10,000 for lump sums paid on or after that date.
Once again, there has been uncertainty over whether a previous lump sum payment that was subject to a payment limit might, in hindsight, be deemed to be an unauthorised payment where a further entitlement is identified and is paid to a member as part of a GMP equalisation exercise.
HMRC’s guidance alleviates these concerns by making clear that, in relation to the lump sums listed above, the limit applies to the amount of the lump sum actually paid. Therefore, “as long as the previous lump sum payment was not more than the relevant payment limit, that lump sum will not stop being an authorised payment purely because, due to GMP equalisation, further entitlement is later identified”.
Trivial commutation lump sums
The situation is different for trivial commutation lump sums, however. In this context, the limit on the amount of the lump sum payment is based on the value of the member’s pension rights under all registered pension schemes on the ‘nominated date’ (i.e. the date nominated by the member being no more than 3 months before the first trivial commutation lump sum payment or, if a member did not make a nomination, the date of payment of the first trivial commutation lump sum payment from any registered pension scheme).
The limit that has applied to the value of the member’s rights on the nominated date has varied over time, as follows:
- nominated date 6 April 2006 to 5 April 2012 – 1% of the standard lifetime allowance
- nominated date from 6 April 2012 and first trivial commutation lump sum payment from any registered pension scheme paid before 27 March 2014 – £18,000
- where the first trivial commutation lump sum payment from any registered pension scheme was made on or after 27 March 2014 – £30,000.
Unfortunately, HMRC has taken the view that because GMP rights were accrued before 6 April 1997, the value of a member’s pension rights on the nominated date includes the members’ ‘equalised GMP’ rights. As a consequence, it may be that as a result of equalising a member’s benefits the value of the member’s rights on the nominated date is found to be more than the relevant limit that applied at that time. If this is the case, the original lump sum payment cannot be a trivial commutation lump sum. Consequently, unless the lump sum can meet the payment conditions for another type of authorised payment, for example a small lump sum, the payment will be unauthorised.
The view adopted by HMRC on this point means that, where a scheme has paid trivial commutation lump sums to members in the past, the trustees will need to:
- check whether the amount paid to each member needs to be increased as a result of the need to equalise benefits for the effect of GMPs, and
- if so, assess whether any additional payment that is due would have caused the total amount paid to a member as trivial commutation lump sums (from all of the member’s registered pension schemes) to have exceeded the payment limit that applied at the nominated date.
It is likely that schemes will need to ask members to confirm (and provide evidence of) the amounts of any other trivial commutation lump sums that they have received from other registered pension schemes, in order to carry out this assessment. However, it is unclear whether schemes will also be required to take account of any top-ups that are payable as a result of GMP equalisation from those other schemes.
Where a top-up payment would result in the amount that has been (and that will be) paid to the member exceeding the relevant limit for the payment of a trivial commutation lump sum, the trustees will need to consider the consequences of this and whether the payments could be treated as being authorised payments on other grounds.
2. Future lump sum payments
2.1 Top-up payments
Having considered the tax consequences for historic lump sum payments, where an additional entitlement is identified as a result of GMP equalisation, the guidance goes on to consider how any top-up payment could be paid to a member or dependent, where it is to be paid as a lump sum, so that the top-up, in itself, can be treated as an authorised payment.
As a starting point, the guidance makes clear that:
- where benefits have previously been paid, depending on the circumstances, a further lump sum payment may be an authorised payment. However, in order to be treated as such, any payment, including a ‘top-up’ payment to a previous lump sum, must satisfy the payment conditions in force at the time the payment is made. This may mean that a top-up lump sum payment cannot be an authorised payment, or it is another form of authorised payment. For example, a top-up payment to a trivial commutation lump sum originally paid in 2015 cannot itself be a trivial commutation lump sum (as it would not be paid within 12 months of the payment of the first trivial commutation lump sum) but it may be possible to pay it as a ‘small lump sum’ if the relevant payment conditions are met.
- where a top-up payment is made that is subject to tax, it will be subject to tax in the tax year in which the top-up payment is made, not the tax year in which the original payment was made.
The guidance then considers the payment conditions applicable to various types of authorised lump sums and considers which may be most likely to be met where a scheme makes a top-up payment to a member or dependent. From this, it appears that the payment of a small lump sum is likely to be the preferred option in most cases where a top-up payment of less than £10,000 is payable.
2.2 Payments made after a scheme has chosen its method for implementing GMP equalisation
In several places the guidance includes statements to the effect that “when schemes have chosen their method of equalising GMP, this will need to be taken into account in calculating and paying [a] lump sum”. The guidance does not make clear what this means. However, it suggests that once a scheme’s trustees have chosen the method that they will use to implement GMP equalisation in respect of some or all of the members of their scheme:
- any lump sum payments that are made to any such members on or after that date should be paid on an equalised basis, taking account of the chosen method, and
- the position outlined above regarding whether a previous lump sum payment has extinguished all of a member’s rights under a scheme or whether it is within a relevant payment limit may no longer apply after this point.
Assuming this is correct, it means that the point at which a scheme’s trustees are deemed to have chosen their method for implementing GMP equalisation may be critical for tax purposes. It also begs the question – at what point will trustees be deemed to have chosen their preferred method? Will it be at the point that a scheme implements any adjustment to members’ benefits or at an earlier stage, such as when the trustees decide on their chosen method?
This question is not answered in HMRC’s guidance. However, it means that care should be taken to record clearly and accurately when trustees have finally decided on their chosen method and to avoid preliminary steps and decisions, such as a decision to assess or investigate the merits of particular options or advice being received on the best option for implementing GMP equalisation, being treated as such. Schemes also need to be aware that on and from the date on which a decision on the chosen method is made all future lump sum payments to members whose benefits are covered by any such decision should be paid on an equalised basis, to avoid unwanted tax consequences.
3. GMP Conversion
At the end of the newsletter, HMRC makes clear that (like the first instalment) this latest guidance does not apply where GMP conversion is used.
The newsletter goes on to say that “the position regarding conversion is complex and its effects within the pension tax rules may have wider impacts. For example, there may be implications when testing against the annual allowance, or whether the deferred member carve out applies, or where an individual has a lifetime allowance protection”. As such, “HMRC is unable to provide supplemental guidance on conversion, as more detailed work needs to be done on the wider issues associated with that methodology. Any schemes wishing to use the conversion method should consider any tax implications that may arise in accordance with the existing legislation and guidance within the Pension Tax Manual and seek advice as appropriate”.
The fact that HMRC has decided that it is unable to issue guidance on GMP conversion is dissappointing given that conversion may represent the best option for implementing GMP equalisation for many schemes. Conversion also offers the opportunity to simplify members’ benefits.
Schemes considering this option will either need to find suitable workarounds to avoid or mitigate the potential tax consequences associated with implementing GMP conversion or they may be forced to implement an alternative approach for the time being with a view to implementing conversion once the associated tax issues have been clarified. However, this may take several years, as several of the issues are likely to require legislative fixes.
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