In today's Budget, A-Day was confirmed as 6 April 2006, dashing occasional recent rumours that it might be postponed once more, to allow everyone (including HMRC) to get their systems ready. Announcements were also made on two specific issues of significance to the pensions industry.

Recycling of pension commencement lump sums

We reported last month on the Government's plans to make payment of a pension commencement lump sum (PCLS) an unauthorised payment, in circumstances where the member was deemed to have used the money to significantly increase contributions to a registered pension scheme (with prior intent to do so). Some of the more polite reactions to this announcement used words like 'sledgehammer' and ‘nut’.

In response to printable comments submitted, HMRC has made just two changes to the draft clause destined for inclusion in the Finance Bill 2006. The 'de minimis' thresholds are amended so that the new rule will not apply where

1. the amount of the PCLS, taken together with any other such lump sums taken in the previous 12 month period, does not exceed 1% of the standard lifetime allowance (was £15,000, so no change at all here for 2006/07); or
2. the amount of the additional contribution(s) does not exceed 30% of the PCLS (was 20%).

These changes are specified in a single page of draft legislation, backed up by two pages of explanatory memorandum and 28 pages of guidance [PDF].

The guidance serves to emphasise the requirement for there to have been prior intent to use the lump sum to facilitate, directly or indirectly, significantly higher pension contributions. It says that the recycling rule will not apply where the member decides after receipt of a PCLS to significantly increase contributions. On the other hand, it also says the period of time over which contributions are to be measured to see if there has been a significant increase is not just the tax year in which the PCLS is taken and the two preceding years, but also the two following years.

The key issue, then, is how do you prove prior intent? Paragraph 4.4 (a new addition to the guidance) states “in the event of a dispute between a HMRC officer and an individual as to whether any recycling was preplanned, the onus will not be on the individual to prove the absence of an intention. However, the HMRC officer will be entitled to take into account any evidence that points towards pre-planning.”

This genuflection to the real world is unfortunately counterbalanced by retention of the onus upon the individual to shop himself: "a scheme member who intends to take a pension commencement lump sum as part of a recycling device will be required to inform the scheme administrator of that fact within 30 days of the date of the deemed unauthorised payment. (The Registered Pension Schemes (Provision of Information) Regulations 2006 (SI 2006/No 567) will be amended in due course to require the member to provide this information.)" (para 15).

Scheme administrators might - they’ll have to beg to HMRC - escape a scheme sanction charge if a member is naughty after they declared they weren't going to be, but it isn’t going to be by any means certain.

We’re still inclined to dub this one 'the Meldrew clause'.

Inheritance tax (IHT)

The background to this issue is as follows. An IHT charge can be levied under section 3(3) Inheritance Tax Act 1984 if a pension scheme members fails to exercise a right to take pension benefits before dying. For example, if a scheme member did not take their pension when their life expectancy was seriously impaired, and this resulted in an enhanced death benefit being paid to their beneficiaries, then IHT could apply. Currently, by concession, IHT is not charged in respect of these enhanced death benefits where the beneficiary is a spouse, civil partner or person who is financially dependant on the scheme member.

The Government consulted last summer on plans to bring death benefits firmly within the scope of IHT, particularly where the member died in ASP (alternatively secured pension, aka drawdown after age 75). The many objections raised have had little effect on the Government's response, unsurprisingly. After accurately describing ASP as an additional option for securing retirement income, today's Budget Note BN 26 reiterates the Government's familiar otherworldly theme that "ASPs are specifically designed for those who have a principled religious objection to annuitisation" and again plaintively notes "It has become clear that some individuals and their advisors are intending instead to use the ASP provisions for a much wider purpose to enable individuals to pass on tax-privileged retirement savings to their dependants rather than to provide a pension in retirement."

In order to prevent this the Government intends to "restrict ASPs to their original limited purpose" by introducing legislation in Finance Bill 2006 to prevent ASPs being used to avoid IHT, by ensuring that appropriate IHT charges apply on left-over ASP funds on death (or later). The intention is as follows:

• any funds paid as a "transfer lump sum death benefit" (i.e. where the funds remain within the scheme for the benefit of other scheme members), or refunded to an employer, or used to provide benefits for a dependant in the pension scheme context who is not a spouse, civil partner or person who is financially dependant, will be subject to an IHT charge on the death of the original scheme member as if the funds were part of the scheme member's own taxable estate on death;
• any funds paid on the death of the scheme member to charity will be exempt from IHT, as will funds expended for the scheme member’s spouse, civil partner or person who is financially dependant on the scheme member;
• any left-over funds, once use by the spouse, civil partner or person who is financially dependant (the beneficiary) has come to an end, will be chargeable to IHT on the earlier of the cessation of those benefits and the death of the beneficiary. These remaining funds will be treated as if they were an addition to the original scheme member's estate. However, any left-over funds that are paid to charity will be exempt from IHT;
• in certain circumstances, an IHT charge on ASP funds will fall on the estate of a dependant (rather than that of the original scheme member). This will apply where a dependant – within the meaning of the pension scheme rules – opts for an ASP derived from "benefits" inherited from a scheme member who died before age 75. Here, any left-over funds on the dependant's death will be charged to IHT as if they were part of the dependant's taxable estate on death.

The current IHT concessionary practice (dating from 1992) for pension scheme members who die before reaching age 75 will also be confirmed in the Finance Bill.