The Taxation of Pension Schemes (Transitional Provisions) Order 2006

Explanatory Note

(This note is not part of the Regulations)

This Order contains further transitional provisions in relation to the new provisions for pension schemes coming into force on 6th April 2006 (“A Day”) pursuant to Part 4 of the Finance Act 2004 (“the 2004 Act”).

Article 2 provides for the modification of section 161 (meaning of payment). The ambit of section 161(3) is extended to cover payments made or benefits provided, from investments purchased by approved schemes before A day. Paragraph 3 of Article 2 excludes certain annuities bought from insurance companies from this extension. Paragraphs 4 and 5 deal with approved schemes which were wound up prior to A day. The wording of section 161(4) is modified in respect of these schemes so that the payment is deemed to be made by a registered scheme.

Articles 3 to 5 provide for commencement provisions for unsecured pensions. Pensions which are in payment by way of income withdrawal before A day and which become unsecured pensions or dependant’s unsecured pension at A day would need to be valued on A day under the existing legislation. These transitional provisions are designed to stagger the date of the valuation exercise to avoid a bottleneck of valuations. Article 3 sets out the pensions which will be covered by these transitional provisions. Article 4 provides for the modification of section 165(1), Pension rule 5. The 120% maximum is reduced to 100% (the pre A day limit) for schemes which have not been re-valued using the new rules. Article 5 makes various modifications to paragraphs 9 and 24 of schedule 28 to enable pensions referred to in article 3 to be re-valued at any time up to 6th April 2006 (or earlier, if there has been an annuity purchase prior to that date). The modifications provide that the pre A Day valuation will be used as the “basis amount” until the new valuation takes place.

Articles 6 to 8 provide transitional protection for people who have pre A Day rights to life cover lump sums where the rules of the pension scheme included such provision on 10th December 2003. Under the new regime lump sum payments made on or after the member’s 75th birthday will be unauthorised. Article 6 sets out the conditions which the member of the registered pension scheme needs to satisfy to qualify for the transitional protection. Article 7 provides for modifications to section 636A of the Income Taxes (Earnings and Pensions) Act 2003 to add life cover lump sums to the list of lump sums exempt from income tax. Article 8 modifies section 168(1) to insert life cover lump sums to the list of lump sum death benefits that a pension scheme is authorised by make under section 164. Paragraph (3) of article 8 adds a new paragraph 21A to Schedule 29 defining “life cover lump sum”.

Articles 9 to 11 provide transitional protection for individuals who qualify for “primary protection” under paragraph 7 to Schedule 36 but whose pre-commencement rights may have been undervalued on 5th April 2006 due to the poor performance of investments held by the scheme. If the scheme receives compensation in respect of the poor performance on or after A day this compensation becomes potentially chargeable to the lifetime allowance charge (section 214). Article 9 sets out the conditions which the individual needs to satisfy to qualify for the transitional protection. Article 10 modifies section 212 (valuation of uncrystallised rights for the purposes of section 210) for the purposes of calculating RR in paragraph 7(3) of Schedule 36. Paragraph (2) deducts the market value of any “relevant compensation” from the amount of RR and paragraph (3) defines “relevant compensation”. Paragraph (4) and (5) apply the modifications to hybrid arrangements (section 212(7). Article 11 modifies paragraph 8(5) of Schedule 36 (valuation of the individual’s uncrystallised right) to ensure that the modifications made by article 10 apply.

Articles 12 to 14 deal with individuals who qualify for primary protection and a lifetime allowance enhancement factor under section 221 in relation to a period of non-residence. The modifications prevent the individual qualifying for two lifetime allowance enhancement factors in respect of the same increase in benefits. Article 12 contains details of the individuals who will be affected by the modifications. Article 13 contains modifications to the value of OV in section 222(4) and (5)(b) to prevent it being indexed prior to A day. Article 14 contains modifications to section 223 (arrangements that are not money purchase arrangements). The definitions of PB and LSB in sub-section (4) are modified so that the rights referred to are valued at 5^th April 2006. Paragraph (3) inserts sub-section (4A) indexing PB and LSB during the active membership period (as defined in section 221(4).

Articles 15,16 and 17 provide transitional protection to contributions make by employers where those contributions qualified for corresponding relief under section 76(6A) and (6C) of the Finance Act 1989. Article 15 sets out the contributions that may be treated as if they were relevant migrant member contributions under paragraph 2 of Schedule 33 and the conditions that must be met in respect of those contributions. Paragraph (4) applies the provisions of the Pension Schemes (Information Requirements – Qualifying Overseas Pension Schemes, Qualifying Recognised Overseas Pension Schemes and Corresponding Relief) Regulation 2005 S.I. 2006/208 to qualifying employees and to exempt employees under article 17. Paragraphs (5) and (6) apply the transitional protection to pension schemes which have received a block transfer from a scheme to which paragraph (2) applies. Article 16 modifies section 245 (restriction of deduction for contributions by employer) for cases which qualify for transitional protection under article 15. Section 245 modifies amends Schedule 24 of the Finance Act 2003 (“the 2003 Act”) and the new modification prevents contributions which have been given relief under article 15 being given double relief under Schedule 24 of the 2003 Act. Article 17 provides that the provisions of section 308A of ITEPA 2003 (exemption of contributions to overseas pension scheme) shall apply to employees (“exempt employees”) who meet the conditions set out in paragraphs (1) and (2) of the article.

Article 18 switches off paragraph 1(1)(b) of Schedule 29 (requirement that lump sum payable only when lifetime allowance available) in the case of an individual whose pension commencement lump sum is determined by paragraphs 27 and 29 of Schedule 36 (enhanced protection).

Article 19 modifies paragraph 2(6) of Schedule 29 (calculation of the available portion of the member’s lump sum allowance) in the case of individuals who fall within paragraph 20(1) of Schedule 36 (individuals who have an actual right to payment of one or more pensions on 5th April 2006). Paragraph 2(6) is modified so that AAC includes any pre-commencement pension rights valued under paragraph 20 of Schedule 36.

Article 20 provides that where a lump sum death benefit is paid in respect of a member who had an actual right to payment of a relevant pension (a pre-commencement pension) immediately before his death, those pre-commencement pension rights will be taken into account when calculating the available amount of lifetime allowance to be set against the lump sum death benefit.

Articles 21 to 23 provide for scheme specific lump sum protection as set out in paragraphs 31 to 34 of Schedule 36 (entitlement to lump sums exceeding 25% of uncrystallised rights) to be lost in respect of rights transferred where there been a partial transfer of those rights (rather than a block transfer) away from a scheme. Article 21 sets out when the modifications in articles 22 and 23 shall apply. Article 22 modifies paragraph 31 of Schedule 36. A new paragraph (2A) is added which provides for the modifications to Schedule 29 made by paragraph 34 (as modified by article 23) to apply to persons where sums and assets representing accrued rights are transferred other than by a block transfer to another scheme. Article 23 modifies paragraph 34 of Schedule 36 so that the amount that has been partially transferred shall be ignored when calculating the “permitted maximum” in paragraph 2 of Schedule 29.

Article 24 disapplies the limit on dependants scheme pensions set out in paragraphs 16A,B and C of Schedule 28 where the member in respect of whom the dependant’s scheme pension is being paid was actually entitled to one or more relevant existing pensions (as defined in paragraph 10(2) of Schedule 36) on 5^th April 2006.

Article 25 and 26 provides transitional protection for individuals whose benefits will only be payable as a lump sum with no connected pension. Paragraph (2) of article 25 sets out the conditions that the individual must meet to qualify for the protection. Paragraph (3) adds a “stand-alone lump sum to the list of lump sums which are authorised payments in section 166(1). Paragraph (4) inserts a new paragraph 3A into Schedule 29 which provides a definition of a “stand-alone lump sum”. Article 26 modifies paragraph 31(3) of Schedule 36 for individuals who meet the conditions set out in paragraph (2) of the article. Paragraph (3) applies the provisions of paragraph 31 of Schedule 36 (entitlement to lump sums exceeding 25% of uncrystallised rights) so that individuals whose benefits are payable as a lump sum only can qualify for the modification of the “permitted maximum” lump sum rules in Schedule 29.

Article 27 deals with contracts which prior to A day, had been approved under section 621(1)(b) of ICTA. Paragraph (3) adds these contracts to the list of pensions in paragraph 1(1) of Schedule 36 which are converted to registered pensions and paragraph (4) adds the contracts to the list of “pre-commencement retirement annuity arrangements” in paragraph 40(3) of Schedule 36.

Article 28 provides that individuals who have become entitled to a tax-free lump sum before A day but deferred their entitlement to the accompanying pension will not become entitled to a second tax-free lump sum under the same arrangement. Paragraph (2) sets out the conditions and paragraph (3)(a) provides that paragraph 1 of Schedule 29 shall be modified so that the tax free lump sum shall be treated as a pension commencement lump sum with a deemed crystallisation on A day. No lifetime allowance charge will arise in respect of the sum however. Paragraph (3)(b) inserts a new paragraph (3A) into paragraph 1 of Schedule 29 which provides that the accompanying pension shall not be a “relevant pension” pursuant to sub-paragraph (3). Any further lump sums paid out in connection with the pension will therefore not be pension commencement lump sums.

Articles 29 modifies paragraphs 8 and 9 of Schedule 28 so that certain types of pension to which the member was entitled immediately before A day shall become unsecured pension funds and accordingly covered by the new regime. Paragraphs (1) and (2) set out the applicable conditions. Paragraph (3) modifies paragraph 8 of Schedule 28 (member’s unsecured pension fund) so that the pensions listed will become unsecured pension funds at A day. Sub-paragraph (d) provides that these rights shall form a separate arrangement and that this deemed designation shall not create a benefit crystallisation event. Paragraph (4) contains amendments to paragraph 9 of Schedule 28 (unsecured pension year and basis amount for unsecured pension year). Paragraph (5) modifies section 216 so that benefit crystallisation events 2, 4 and 8 are not triggered when the unsecured pension funds are utilised to provide a scheme pension, lifetime annuity or rights under a qualifying recognised overseas pensions scheme. This paragraph is necessary because the provisions in paragraphs 3 and 4 of Schedule 32 preventing overlap do not apply appropriately to these funds that were in existence before A day.

Article 30 provides similar provisions to article 29 for dependant’s pension funds. Paragraphs (1) and (2) set out the conditions which the dependant must meet for the modifications to take effect. Paragraph (3) modifies paragraph 22 of Schedule 28 (dependant’s unsecured pension fund) so that the unsecured pensions listed will become dependant’s unsecured pension funds at A day. Paragraph (4) contains amendments to paragraph 23 (unsecured pension year and basis amount for unsecured pension year).

Article 31 provides for certain individuals over the age of 75 at A day to be treated as being in alternatively secured pension from A day. Paragraphs (1) and (2) set out the conditions to be met for the modification to apply. Paragraph (3) modifies paragraph 11 of Schedule 28 (member’s alternatively secured pension fund) so that the sums and assets that meet the inserted condition C shall become member’s alternatively secured pension funds at A day. The effect of paragraphs (4), (5) and (6) is that certain individuals over the age of 75 who were already drawing a pension on 5^th April 2006 will have their funds automatically converted to member’s alternatively secured pensions funds pursuant to paragraph 11 of Schedule 28. Paragraphs (4) and (5) set out the conditions that must be met for the modifications to apply. Paragraph (6) modifies paragraph 11 of Schedule 28 so that sums and assets which meet the inserted condition C shall become member’s alternatively secured pension funds.

Article 32 contains similar provisions to those in article 31 for dependant’s alternatively secured pension funds. Paragraphs (1) and (2) set out the conditions that must be met by the dependant. Paragraph (3) contains modifications to paragraph 25 of Schedule 28 (dependant’s alternatively secured pension fund) so that the sums and assets which meet the inserted condition C shall become dependant’s alternatively secured pension funds.

Article 33 deals with serious ill-health lump sums, pension protection lump sum death benefits and annuity protection lump sum death benefits. Paragraphs (1) and (2) set out the applicable conditions. Paragraph (3) modifies paragraph 4 of Schedule 29 (serious ill-health sum) to prevent an individual who already had an actual right to payment of a relevant pension at A day being paid a serious ill-health lump sum. This reflects the position in the new regime. Paragraphs (4) and (5) modify paragraphs 14 (pension protection lump sum death benefit) and 16 (annuity protection lump sum death benefit) so payments of pension protection lump sum death benefits and annuity protection lump sum death benefits can be made in respect of individuals who fall within the conditions set out in paragraphs (1) and (2). In the new regime these lump sums must not exceed a protection limit. Individuals who meet the conditions would have a limit of £0 as the limit is defined by reference to “the amount crystallised”. The concept of crystallisation is not applicable to pensions before A day so this is changed to the value of the individuals pre-commencement pension rights.

Article 34 provides transitional protection for dependants over the age of 23 who are in full time education or have become incapacitated before that age. The conditions are set out in paragraphs (1) (4), (5) and (6) and paragraph (3) modifies paragraph 15(2) of Schedule 28 (meaning of “dependant”).

Article 35 modifies paragraph 12(8) of Schedule 36 (“enhanced protection”) so that transfers to insurance companies which are recognised transfers pursuant to section 169(1A) are “permitted transfers”. If the transfer was not a permitted transfer, enhanced protection would be lost.

Article 36 protects an individual’s right to enhanced protection in the event of a transfer made in connection with a wind-up. Paragraphs (1) and (2) set out the applicable conditions. Paragraph (3) modifies paragraph 15 of Schedule 36 (definition of the “relevant crystallised amount”) so that transfers representing crystallised rights which are made in connection with a wind-up shall be valued at £0 for the purposes of calculating the relevant crystallised amount.

Article 37 modifies section 636B ITEPA 2003 (trivial commutation and winding-up lump sums). The section provides for the taxation of trivial commutation lump sums or winding-up lump sums. Paragraph (1) sets out the lump sums that the modification will apply to. Paragraph (2) substitutes a new heading and paragraph (3) adds an “equivalent pension benefits commutation lump sum” to the list in section 636B(1). Paragraph (4) inserts a definition of “equivalent pension benefits commutation lump sum” to the section.

Articles 38 to 41 contain transitional provisions in relation to various lump sums which had become payable under the pre A day regime. Article 38 provides that lump sum payments which meet the conditions set out in paragraph (1) shall be chargeable to income tax in accordance with section 598, 599 or 599A of ICTA even though they were paid after A day. The article applies to lump sums payments which were payable in accordance with the rules of the pension scheme before A day. The article also provides that the reporting requirement shall transfer to the scheme administrator. Article 39 deals with lump sums paid to a member in circumstances of the member’s serious ill-health. Paragraph (2) provides that there is no charge to tax under Part 4 if the sum meets the requirements set out in sub-paragraphs (a) to (d) of article 38(1) (i.e that the sum was paid after A day, in accordance with the rules of the scheme as they stood prior to A day). Paragraphs (3) and (4) set out when a lump is paid in circumstances of the member’s serious ill-health. Article 40 deals with lump sum death benefits payable in respect of the death of a member who died before A day. Paragraph (1) sets out the circumstances in which the article will apply which are similar to those set out in article 38. Paragraph (2) provides that the lump sum shall not be a relevant lump sum death benefit as defined in paragraph 15 of Schedule 32 (benefit crystallisation event 7: meaning of “relevant lump sum death benefit”) and shall be disregarded for the purposes of benefit crystallisation event 7. Paragraph (3) states that the lump sum shall be chargeable under section 648B as if the section was still in force following A day. Paragraph (4) provides that the reporting requirements shall transfer to the scheme administrator. Article 41 provides that paragraphs (3) to (5) of article 40 shall apply to lump sums paid in respect of the death of a dependant of a former member of a pension scheme prior to A day.

The Board of Inland Revenue published a regulatory impact assessment in respect of the provisions of Part 4 of the Finance Act 2004, and subordinate legislation under it, on 8 April 2004. That assessment is now available on the website of HM Revenue and Customs at www.hmrc.gov.uk/ria/simplifying-pensions.pdf or obtained by writing to The Ministerial Correspondence Unit, 1st Floor, Ferrers House, PO Box 38, Castle Meadow Road, Nottingham, NG2 1BB.