Article How tax relief works on your employer contributions

As an employer, you’re required to pay pension contributions for eligible employees under auto-enrolment.

One of the benefits of making contributions is that they can be used to reduce your corporation tax bill. So, you could decide to go a step further than your legal obligations by paying more than the auto-enrolment minimums, or by making employer contributions for all your employees.

Here we explain how this tax relief works – and help you identify if you’re eligible by answering some commonly asked questions. We’ll also explain how salary sacrifice could enhance the tax benefits for you and your employees. This information is based on our understanding of current taxation law and HMRC practice, which may change. The value of any tax relief will depend on individual circumstances.

The basics of tax relief on employer contributions

As an employer, you’ll pay contributions to your pension provider as gross amounts, regardless of the type of UK registered pension scheme in place. As long as these contributions are deemed ‘wholly and exclusively for the purpose of trade’ – meaning the payments are specifically for business purposes only – you can offset them against taxable profits to reduce your corporation tax bill.

Corporation tax is paid on your annual profits – and employer pension contributions can be deducted from profits before corporation tax is calculated. For example, if taxable profits in a tax year are £50,000, and £10,000 is paid in employer pension contributions, this means that corporation tax will only be calculated on £40,000. This is ignoring any other deductions that may be available.

The main rate of corporation tax (for businesses with profits of £250,000 or above) is 25%.¹ If your business has profits of £50,000 or less, you’ll pay the ‘small profits’ rate of 19%. If your profits fall between £50,000 and £250,000, you can claim marginal relief, which provides a gradual increase in your corporation tax rate between the small profits rate and main rate.¹ Find out more about marginal relief and calculate how much you could claim on this government webpage.

You should know that a reduction of your corporation tax bill isn’t automatic – it’s given at the discretion of your company’s local Inspector of Taxes.

Will my company qualify for tax relief on pension contributions?

For a trade or profession, employer contributions are tax deductible if they’re incurred ‘wholly and exclusively for the purposes of the trade or profession’. For an investment company, employer contributions are deductible if they’re classed as an expense of management.

It’d be unlikely for your employer contributions paid into a pension scheme to not meet the ‘wholly and exclusively’ rule. HMRC emphasise that as part of the cost of employing staff, pension contributions will be allowable. They also state that it’d be relatively rare to have to consider whether there’s a non-trade or non-business purpose for an employer's decision to make a pension contribution. It will always be a question of fact as to whether that’s the case or not.

Simply put, any pension contribution you make as an employer to a registered pension scheme – in respect of any director or employee – will receive corporation tax relief unless there’s a non-trade or non-business purpose for the payment.

You can find out more about employer pension contributions and corporation tax relief in HM Revenue & Customs’ Business Income Manual.

Could salary sacrifice benefit my business and my employees?

Offering your employees the option of using salary sacrifice with their workplace pension could be beneficial for them and provide savings for you as an employer.

By ‘sacrificing’ some gross salary in exchange for an enhanced employer pension contribution, employees save on their National Insurance Contributions (NIC). This saving can be used to increase take home pay or add to the amount going into pension savings, or both – with no additional costs to the employee.

In addition, as the salary that is sacrificed is paid as an employer contribution, you’ll see a reduced employer NIC bill, as employer pension contributions don’t attract NICs. You could choose to add some or all of this saving to the pension contribution as part of the salary sacrifice, but you don’t have to.

Notably, increased employer contributions from a salary sacrifice arrangement are likely to be treated as ‘wholly and exclusively for the purposes of trade’. This means they’re allowable as a deduction when calculating a company’s taxable profits – potentially reducing your corporation tax bill further.

Salary sacrifice can’t reduce an employee’s gross salary below the National Minimum Wage or the National Living Wage (whichever applies), so it’s not suitable for everyone. It may also impact the amount of money they can borrow for a mortgage, or their entitlement to State benefits. It’s important you point out and talk through the benefits and consequences of salary sacrifice with your employees before they enter into an agreement.

We recommend consulting your scheme adviser to help decide the best course of action for your business.

To learn more about how salary sacrifice works, check out our article, Salary sacrifice for employers – what you need to know.

What else do I need to know?

Although there’s effectively no limit to how much in employer contributions you can make for an employee in a tax year, your contributions will count towards your employees’ annual allowance. Any personal contributions your employees make – plus any third-party contributions paid on their behalf to any registered pension scheme – will also be included in their annual allowance for the tax year.

Contributing to your employees’ pension pots could provide a welcome boost to their retirement savings and future financial security. And while demonstrating your support, you might see the added bonus of tax relief and increased scheme engagement.

For more articles and insight to support you with managing your workplace pension scheme, visit our Employer Insights hub.