Tax policy on directors' pensions challenged

The Inland Revenue is facing a legal challenge over a new practice of imposing a 40 per cent tax charge on lump sum pension payments made to directors who retire early but continue to work for the company. Separately, pension actuaries warned interest rates under EMU would be driven up unless Europe's trillion-pound pension liabilities were addressed. Andrew Verity reports.

The pensions industry is preparing to seek a judicial review over the Inland Revenue's practice of taxing lump-sums previously thought to be tax-free. The practice, which the industry believes is part of the Government's "spend-to-save" clampdown on tax loopholes, has led to many directors of small companies paying unexpected six-figure sums in tax.

The Revenue's Pension Schemes Office is targeting directors who retire and draw pension benefits, but stay on the board in a reduced role - usually as a non-executive director or as a consultant.

The Revenue claims this breaks rules that bar people from working once they have drawn their pension benefits from company schemes. It is applying the practice even to unpaid, non-executive directors.

The Association of Pensioner Trustees, which represents trustees of small company pension schemes, is preparing to mount a legal challenge over what it claims is an un-announced change of practice.

Further, the Revenue has told the APT that the practice is universal and could apply to any member of an occupational pension scheme who retires early but then resumes working for the same employer. Potentially, any employee who, after drawing a tax-free lump sum, stays on the pay-roll could be hit with a retrospective tax charge.

The APT says that while the Inland Revenue claims the practice is universal, it is also targeting directors of small companies, many of whom stay on the board purely to hand over the reigns to successors.

In one example, a director of a packaging business, who asked not to be named, retired in 1992 with a lump sum payment of more than pounds 400,000. He had remained on the board while the company was being wound-down. Adrian Waddingham, of actuaries Barnett Waddingham, said: "I have complained to the Revenue that the only cases that have been brought to my attention are controlling directors. But the Revenue has told me this does apply to larger companies. There are countless examples of directors retiring early but working for them later."

While the Revenue insists it has not changed its practice, the rules are by no means universally applied. Gillian Shepherd, the former education minister, said when still in government that she "had no objection" to teachers retiring early and then resuming work for their education authority. Lump sums have remained tax-free.

In a separate development, the Association of Consulting Actuaries warned that interest rates would rise under EMU if governments did not address the issue of unfunded pension liabilities.

The issue caused a great deal of controversy following a report from the House of Commons select committee, led by then-backbencher Frank Field. Mr Field, now minister for welfare reform at the DSS, said before the election that he believed it made no economic sense for Britain or any other country to join a single currency.

Paul Thornton, chairman of the association, warns that EMU convergence criteria fail to account for the liabilities, which across Europe amount to more than pounds 1,000bn. While Britain has more than pounds 750bn in funded pensions, Italy, France, Germany and Spain have giant future liabilities because of generous benefits paid for from taxes.