People contributing to a personal pension or retirement annuity contract (policies taken out on or before 30 June 1988) deduct the relevant premiums from their current year's profits (either as self-employed workers or business partnerships), and are also allowed to carry back contributions to be deducted from the previous year's earnings as well. Relief is given in relation to the tax year in which the payment is made. But the amount of relief is calculated as if it was carried back into the previous year.
Many taxpayers wait until their accounts are finalised before making a one-off contribution to their pension plan for that year, and the related tax is then deducted by the Revenue from that year's assessment. And because of the gap which exists, under the current procedures, between the period during which income is earned and the point at which the relevant tax is due, there is enough time for the related tax to be knocked off the assessment for the previous year as well, if the contribution is carried back.
This relatively relaxed manner of doing business is being sharpened up by the new system of self-assessment, which moves taxation on to a "current year" basis in order to give the Revenue more certainty as to when, and how much, tax will be paid. It means that the gap between earning income and paying the related tax will be telescoped, so that there will be less time for taxpayers to make the "carried back" contributions if they want to deduct relief from their tax bill for that year as it is paid, rather than claim the deduction at a later date.
There are, in fact, two separate problems. First, there is the issue of the "carried back" pension contribution itself. And there is also the problem of deducting that relief from payments on account for the following year, since under the new system these will be fixed at the same level level of the assessment. (Payments on account will be made twice yearly, on 31 January and 31 July, with any balancing payment made the following January.)
For example, for your trading year which ends during the 1997/98 tax year, you must file accounts by 31 January 1999, or 30 September 1998 if you want the Revenue to calculate your tax. Suppose you then make a pension contribution during the 1998/99 tax year, but want to relate it back to your 1997/98 trading year. If you make the payment during 1998/99 before you submit the return on 31 January 1999 (or 30 September 1998, if the Revenue is working out your tax bill) you can take it into account for your 1997/98 accounts. But if you pay the premium after submitting the return, you have to make a separate claim for relief.
Payments on account for the 1998/99 tax year would be due on 31 January 1999 and 31 July 1999. Each would be 50 per cent of the final payment for the previous year. But any deduction for pension premiums would depend on payments made before 31 January 1999 at the latest.
At one stage it was feared by tax advisers that "carry back" tax relief might be lost altogether. However, in response to representations from the Chartered Institute of Taxation and other bodies, the Inland Revenue has now issued a press release confirming that relief will still be available as before, but will operate under the rules of the new system. This means that you will only be able to claim relief for pension contributions made before you submit your tax return for the relevant year.
The transitional concession comes in for pension contributions made during the current tax year (1996/97) and carried back to the previous year (1995/96) to reduce the assessment for 1995/96. This also means that the level of payments on account for the 1996/97 tax year - due on 31 January 1997 and 31 July 1997 - will be correspondingly reduced.
"But the problem is still going to be there in future years," says Hywel Jones, the technical officer of the CIOT, who runs his own accountancy practice in Caernarfon, North Wales. "And though claims can be made outside the annual return, this can lead to a lot of administrative paperwork."
One possible solution during the transitional period is this. Your payments into your pension during 1996/97 will be used for calculating tax relief on your payments on account during 1997/98. So paying pension contributions during 1996/97 of twice the Inland Revenue limit (one to carry back and one for the current year) should reduce the level of payments on account you will be required to make. But of course not all taxpayers can afford to make double the contribution in one year.
For 1997/98 onwards, however, Jones's advice is fairly basic. "You're probably best off simply making the contributions in the tax year itself, rather than relating them back," he says. "If you do want to relate them back, you should make these contributions as early as possible In the tax year."
One thing is certain from all this is: the timing of pension contributions is even more critical than before. Anyone who is self-employed or working in a business partnership and who thinks they may be affected should therefore seek professional advice in timing these payments to minimise any negative effect on their cashflow.