Tax ‘super-deduction’ could leave DB schemes short-changed

The super-deduction announced by the chancellor, Rishi Sunak, allows companies to claim 130 per cent of capital allowances on qualifying plant and machinery investments.

This amounts to a tax cut of 25p for every £1 the company invests, and is intended to spur the post-Covid economic recovery while making the UK’s capital allowance regime “more internationally competitive”, according to a fact sheet published by HM Treasury.

Insofar as the outcome was a reduced level of employer contribution, both the employer and trustees would need to be very certain in their argument that it is the right thing to do. I suspect TPR would take a dim view of a poorly argued case

Richard Butcher, PTL

The government had deemed it especially important as rates of business investment, already low before the pandemic, fell 11.6 per cent between the third quarter of 2019 and Q3 2020.

But experts have said that while the cut, in place for two years, is likely to help businesses recover following the lifting of the lockdown restrictions, it amounts to a powerful incentive that could see funds diverted away from paying back pension scheme deficits.

Matthew Giles, partner at Squire Patton Boggs, told Pensions Expert that there will be a clear incentive for businesses to “seize that opportunity and steer all available cash into investment and equipment to take advantage of that tax break”.

“Where will that money have otherwise been spent? Possibly on the pension scheme,” Giles said.

Though paying large amounts in deficit repair contributions is tax-efficient, it is not as tax-efficient as the 130 per cent super-deduction, he argued.

“Given that the deduction is only there for two years, I think there is a real chance that people will be asking for two years’ leeway on their pension contributions so that they can invest in the business and get this really favourable tax treatment.”

He added that the super-deduction is likely to appeal in particular to the type of businesses, not least in manufacturing, that typically have legacy defined benefit schemes, which will be subjected to competing pressures.

Likewise, trustees, who will have to balance the need for regular contributions with the need for a strong and solvent employer, may find themselves under pressure — especially if they face a 2021 valuation — to agree to a reduction in payments in order for the employer to invest in its survival.

“Trustees will need to get experts involved to advise on whether it’s a good use of the money,” he said.

Trustees ‘unlikely’ to agree unless in exceptional circumstances

Mark Smith, partner at Taylor Wessing, cast doubt on the likelihood of trustees agreeing to altered or amended funding arrangements unless there is a clear and exceptional case to be made for them.

“There is a difference between the employer wishing to free up some cash to take advantage of an opportunity, such as the one at issue, and employers needing to free up some cash to be able to continue to trade, as has been the case in relation to certain requests to defer deficit reduction contributions made over the past year or so,” he explained.

While in the latter case trustees can agree to some “short-term pain” in a bid to ensure there is a medium or longer-term future for the business, Smith said that “in situations where the trustees have no reason to be concerned that the employer cannot pay the contributions that it has committed to pay, at the times when it has committed to pay them, trustees are unlikely to want to agree to any change”.

There may be a difference, however, if there is an actuarial valuation under way “or some other compelling reason to reassess the funding position”, he continued.

“Part of the discussion will invariably be around what is beneficial to the employer covenant, such as [in principle] the employer investing in its business and receiving preferential tax breaks for doing so.” 

In those circumstances, “trustees will need to weigh that up against what amounts the scheme might need and at what times, and what security might be available to guard against any risks arising, in any discussions with the employer about any opportunities that might arise out of the first-year super-allowance capital deduction that will be available over the next two years”, Smith added.

‘Too early to say’ how things will pan out

Richard Butcher, managing director at PTL, told Pensions Expert that reducing or deferring contributions would “require a breach of or change to the deficit repair schedule”, which would in turn “require a report from the trustees to the [Pensions Regulator]”.

“It would be a brave employer who unilaterally breached the schedule of contributions now that TPR has powers under s107 [of the Pension Schemes Act] to imprison conduct risking accrued benefits, particularly as those powers are new and untested,” he said.

A change in schedule would also require a complete actuarial review, which could itself take a full year to conclude, Butcher added.

“Insofar as the outcome was a reduced level of employer contribution, both the employer and trustees would need to be very certain in their argument that it is the right thing to do. I suspect TPR would take a dim view of a poorly argued case,” he said.

Steve Delo, chairman of Pan Trustees, concurred with this assessment.

A sponsor’s argument that they should be able to take advantage of the super-deduction at the short-term expense of the scheme is unlikely to be accepted, “unless there is some compensating factor delivered”, he said. 

“As ever, trustees need to take proper covenant advice and evaluate matters in an integrated risk management fashion.”

Delo added: “Unless there is a valuation in process, I don’t see many trustees reopening the debate over existing recovery plans.”

A TPR spokesperson told Pensions Expert: “We expect trustees to undertake due diligence on the employer’s financial position before agreeing a new repair plan.”