Navigating the withholding tax issues when administering payments of arrears of pension and associated interest.
Pension scheme trustees, and those responsible for administering pension schemes, sometimes need to correct instalments of pension that turn out to have been underpaid and make top-up interest payments. They are then faced with questions relating to how those interest payments should be taxed. What information should be given to the scheme member receiving the interest payment regarding their own tax position (assuming the scheme administrator wants to say anything at all here)? And, more importantly, perhaps, for the scheme administrator, do they need to withhold tax when making those interest payments?
HMRC’s Pension Schemes Newsletter 156 (published on 23 February 2024) contains a helpful reminder that the technical position set out in Newsletter 140 (published on 30 June 2022) for the tax treatment of interest paid on arrears of pension reflects the position generally and is not limited to the context of equalising for guaranteed minimum pensions.
Whilst the arrears of pension will be taxed as pension income, and tax must be deducted from the arrears under PAYE, that is not the case for the related interest payment.
The member should be taxed on the interest received under ITTOIA 2005 s 369. This means that the interest should be treated as ‘savings income’ and might qualify for the individual’s personal savings allowance.
The requirement (if any) to withhold tax from the interest payment arises under ITA 2007 s 874 – and not under the rules relating to PAYE. This means that the obligation to withhold tax arises only if the interest is ‘yearly’ interest. There is no obligation to withhold tax under s 874 from payments of ‘short’ interest. Assuming that the arrears of underpaid pension span at least twelve months, then the interest paid is likely to be treated as ‘yearly’ interest.
The obligation to withhold tax under s 874 is, however, more limited in scope than the obligations to withhold in relation to PAYE. Newsletter 140 makes clear that HMRC’s view is that where yearly interest relating to pension arrears is paid by ‘individual trustees, a corporate trustee, or a third-party administrator on a trustee’s behalf, there will be no obligation on the payer to deduct income tax at source unless the payment is made to a person who usually lives outside the United Kingdom’.
This is also a much more limited withholding tax obligation under s 874 than where a company makes (other than in a fiduciary or representative capacity) a payment of yearly interest. In that case (which is likely to be unusual in the context of occupational pension schemes paying interest on arrears of pension) there can be an obligation to withhold tax regardless of the recipient’s place of abode.
Another fundamental difference between the obligation to withhold tax under s 874 and the PAYE rules is the rate to be applied. In the former case, where tax is required to be deducted, this is (in the absence of any relevant double tax treaty) at the basic rate of (currently) 20%.
It will, therefore, be important when administering payments of arrears of pension and associated interest for those payments to be properly broken down into pension arrears and interest and for the correct withholding tax regime to be applied to the constituent parts. It won’t, unfortunately, simply be a case of applying PAYE withholding to the entire payment of arrears and interest. That would potentially result in administrators withholding tax on an incorrect basis, leaving members in the position of having either underpaid or (more probably) overpaid tax on the interest component.
The above all assumes that the interest payments on arrears of pension will constitute ‘authorised payments’ for pensions tax purposes, falling into the category of a ‘scheme administration member payment’. Newsletter 156 confirms this should be the case ‘where interest is provided on an arm’s length commercial basis’ or, in other words, ‘where interest is payable at no more than a reasonable commercial rate of interest’. Reference is made in the Newsletter to the relevant section of HMRC’s Pensions Tax Manual (PTM143100). If a scheme decides to pay interest ‘at a rate in excess of a commercial rate’, then HMRC confirms in Newsletter 156 that this will constitute an unauthorised payment, subject to the usual unauthorised payment tax charges, which apply both to the member and the scheme. This might be the case, even if this rate is set out in, and mandatory under, the scheme’s rules.
Home >Articles > Interest on pension arrears: deduction of tax on cross-border payments
Interest on pension arrears: deduction of tax on cross-border payments
Navigating the withholding tax issues when administering payments of arrears of pension and associated interest.
Pension scheme trustees, and those responsible for administering pension schemes, sometimes need to correct instalments of pension that turn out to have been underpaid and make top-up interest payments. They are then faced with questions relating to how those interest payments should be taxed. What information should be given to the scheme member receiving the interest payment regarding their own tax position (assuming the scheme administrator wants to say anything at all here)? And, more importantly, perhaps, for the scheme administrator, do they need to withhold tax when making those interest payments?
HMRC’s Pension Schemes Newsletter 156 (published on 23 February 2024) contains a helpful reminder that the technical position set out in Newsletter 140 (published on 30 June 2022) for the tax treatment of interest paid on arrears of pension reflects the position generally and is not limited to the context of equalising for guaranteed minimum pensions.
Whilst the arrears of pension will be taxed as pension income, and tax must be deducted from the arrears under PAYE, that is not the case for the related interest payment.
The member should be taxed on the interest received under ITTOIA 2005 s 369. This means that the interest should be treated as ‘savings income’ and might qualify for the individual’s personal savings allowance.
The requirement (if any) to withhold tax from the interest payment arises under ITA 2007 s 874 – and not under the rules relating to PAYE. This means that the obligation to withhold tax arises only if the interest is ‘yearly’ interest. There is no obligation to withhold tax under s 874 from payments of ‘short’ interest. Assuming that the arrears of underpaid pension span at least twelve months, then the interest paid is likely to be treated as ‘yearly’ interest.
The obligation to withhold tax under s 874 is, however, more limited in scope than the obligations to withhold in relation to PAYE. Newsletter 140 makes clear that HMRC’s view is that where yearly interest relating to pension arrears is paid by ‘individual trustees, a corporate trustee, or a third-party administrator on a trustee’s behalf, there will be no obligation on the payer to deduct income tax at source unless the payment is made to a person who usually lives outside the United Kingdom’.
This is also a much more limited withholding tax obligation under s 874 than where a company makes (other than in a fiduciary or representative capacity) a payment of yearly interest. In that case (which is likely to be unusual in the context of occupational pension schemes paying interest on arrears of pension) there can be an obligation to withhold tax regardless of the recipient’s place of abode.
Another fundamental difference between the obligation to withhold tax under s 874 and the PAYE rules is the rate to be applied. In the former case, where tax is required to be deducted, this is (in the absence of any relevant double tax treaty) at the basic rate of (currently) 20%.
It will, therefore, be important when administering payments of arrears of pension and associated interest for those payments to be properly broken down into pension arrears and interest and for the correct withholding tax regime to be applied to the constituent parts. It won’t, unfortunately, simply be a case of applying PAYE withholding to the entire payment of arrears and interest. That would potentially result in administrators withholding tax on an incorrect basis, leaving members in the position of having either underpaid or (more probably) overpaid tax on the interest component.
The above all assumes that the interest payments on arrears of pension will constitute ‘authorised payments’ for pensions tax purposes, falling into the category of a ‘scheme administration member payment’. Newsletter 156 confirms this should be the case ‘where interest is provided on an arm’s length commercial basis’ or, in other words, ‘where interest is payable at no more than a reasonable commercial rate of interest’. Reference is made in the Newsletter to the relevant section of HMRC’s Pensions Tax Manual (PTM143100). If a scheme decides to pay interest ‘at a rate in excess of a commercial rate’, then HMRC confirms in Newsletter 156 that this will constitute an unauthorised payment, subject to the usual unauthorised payment tax charges, which apply both to the member and the scheme. This might be the case, even if this rate is set out in, and mandatory under, the scheme’s rules.
