Pension lawyers say there is confusion over the wording in the legislation that governs how much tax must be paid to transfer defined benefit surplus payments to employers, with one interpretation leading to a lower tax charge than the other. 

Many DB pension funds have benefitted from rising gilt yields, with liabilities often falling more than assets. This has resulted in considerable surpluses, which some employers are seeking to gain access to. 

 
The renewed focus on recouping pension fund surplus has thrown up a seemingly simple question, asked at an event organised by law firm Baker McKenzie in London on 3 July. One audience member wondered how the surplus tax charge needed to be calculated, noting there were “differing views in the market”.

Baker McKenzie partner Jonathan Sharp explained that the 25% payment could be seen to apply either to the total surplus, or just the sum the employer receives. 

For a hypothetical scheme with a £100m surplus, it is therefore unclear if HM Revenue & Customs should receive £25m or £20m. 

Sharp said the former would seem “completely logical”, but “when you look at the legislation, there’s a different way of looking at it”. A scheme and its employer might consider that the 25% applies to the sum the employer receives, rather than the gross amount. 

“Now I feel it should be the first, but I’ve looked at the legislation and I think it’s the latter,” Sharp opined. 

Other examples that work this way are worded similarly, which would support this view, he added, “but it doesn’t feel right”. 

The difference between this piece of legislation and others that are worded similarly is that in the others, the tax is paid by the recipient, rather than the trustees who make the transfer of money.

"I think that leads to a slightly different outcome," he said.

Even if the way the legislation is worded comes down on the side of the lower amount, the audience member who had asked the question suggested a pension fund and its sponsor might not want to risk taking that approach, as it could worsen their overall relationship with the tax authorities.

The Pension Tax Manual provides guidance on how authorised surpluses are taxed and reported.

The tax charge on return of surplus was reduced to 25% from previously 35% from 6 April, via the Authorised Surplus Payments Charge (Variation of Rate) Order, SI 2024/335. Although the wording in the Finance Act 2004 has not been changed, it is examined more closely now that surpluses are substantial enough for companies to consider accessing them.