EXPLANATORY NOTE

1. This clause and schedule introduce changes to pension scheme tax rules where pension rights are shared on divorce. These changes complement amendments to social security, matrimonial and family law in the Welfare Reform and Pensions Bill which allow for pension rights to be shared as part of a financial settlement on divorce and will, in general, take effect from the date that the provisions in that Bill are commenced. Once the changes are in force, the parties to a divorce will be able to share pension rights without affecting the tax approved status of the pension scheme.

General

2. The legislative changes, in the main, relate to the prescribed conditions in section 590 of the Taxes Act 1988 for tax approval of retirement benefits schemes and to the sections, relating to the tax approval of personal pension schemes in Chapter IV Part XIV Taxes Act 1988.

3. Current pensions legislation is framed on the basis of provision of benefits for the individual scheme member (employee in the case of a retirement benefits scheme) with benefits for a surviving spouse or dependant following the death of the scheme member. It broadly prohibits the assignment or surrender of any pension or annuity.

4. Under the pension sharing provisions in the Welfare Reform and Pensions Bill it is proposed that a pension share will result in the reduction of the employee scheme member’s pension rights (pension debit) with a consequential allocation of rights to the ex-spouse (pension credit). This transfer of pension rights between the parties to a divorce would contravene the prohibition in the Taxes Act 1988 on the assignment or surrender of benefits. This ban will therefore be removed where a pension sharing order or provision in accordance with the Welfare Reform and Pensions Bill is confirmed by the courts.

5. The schedule also will provide for the pension credit rights allocated to the ex-spouse following a pension share to be secured (independently of those of the scheme member) either under the member’s scheme or by transfer to another pension arrangement. Where the ex-spouse’s pension credit rights arise from a tax approved pension scheme a transfer will be permitted only to another tax approved arrangement.

6. Generally, the benefits from pension credit rights for an ex-spouse will be payable within the usual retirement age range of 50 to 75. To maintain consistency with the normal tax rules for pensions, an ex-spouse may be given benefits which broadly follow those available to a scheme member. For example, where a scheme member could exchange part of a pension for a lump sum at pension date the ex-spouse also would have a lump sum option. And, where a tax charge would arise on the benefits of a scheme member, an ex-spouse’s benefits which are payable in the same circumstances would also be taxable; for example, where a very small pension is exchanged in full for a lump sum. Pension or annuity payments to an ex-spouse will be chargeable to tax on the ex-spouse under the rules of Schedule E.

7. There will be no limit under the tax approval rules on the pension for an ex-spouse from pension credit rights. Any tax-free lump sum in respect of those rights will be limited; to 2.25 times the ex-spouse pension in the case of a retirement benefits scheme and to 25% of the fund under a personal pension scheme. Where appropriate, these limits will be subject to any rules for safeguarded rights under the Department of Social Security’s ‘contracting-out’ requirements.

8. Where an ex-spouse’s pension credit rights arise from an arrangement which does not allow for a tax-free retirement lump sum, for example, a free standing AVC scheme, the ex-spouse may receive benefits only in pension form. Similarly, if a tax-free retirement lump sum has been taken by the scheme member before pension sharing took place (for example the pension was in payment when it was shared) then the ex-spouse pension credit rights would be limited to a pension only.

Impact on the scheme member

9. Under the Welfare Reform and Pensions Bill the pension debit for a member of a defined benefit retirement benefits scheme will be recorded by the scheme manager and deducted from the benefits payable on retirement (or earlier on leaving pensionable service). For tax approval purposes, this pension debit may be ignored under all types of retirement benefits schemes, when calculating the maximum benefits for a scheme member (excluding a controlling director) who earns not more than ¼ of the ‘earnings cap’ (£22,650 for 1999/2000). For other retirement benefit scheme members, pension debits will continue to count in the calculation of maximum benefits under the tax approval rules.

10. A pension debit will also affect the maximum amount of tax-free cash which may be taken at retirement by scheme members. For those members of a retirement benefits scheme whose lump sum benefits are linked to the initial amount of pension, the limit will be based on the actual pension payable to them under the scheme. Where the retirement benefits scheme does not impose such a link, the maximum tax-free lump sum under the scheme rules may have to be reduced to take account of the pension debit. Where the individual is a member of a personal pension scheme, the tax-free lump sum payable will be 25% of the value of the fund at the time benefits become payable.

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11. Clause 70 introduces Schedule 10

12. Paragraph 1 extends the classes of insurance policy or contract that can be included in an insurance company’s tax exempt ‘pension business’ defined in section 431B Taxes Act 1988. The aim of this paragraph is to ensure that where pension credit rights for an ex-spouse arise from a source which qualifies as ‘pension business’, the insurance policy or contract under which these pension credit rights are secured similarly qualifies for ‘pension business’. It does this by making two additions. New sub-paragraph (ea) to subsection (2) relates to contracts securing pension credit rights s for an ex-spouse following a pension share of an annuity contract which secured benefits for a former member of a retirement benefits scheme. And, new subsection (2A) enables pension credit rights to be secured by the trustees of a tax approved retirement benefits scheme by purchasing an annuity for an ex-spouse. Both these changes ensure that ex-spouse pension policies or contracts qualify for tax exemption on the investment build-up of the insurance company’s funds.

13. Sub-paragraph 1(2)(a) is not directly related to pension sharing. It has been included to put beyond doubt that where a former scheme member transfers funds from a substitute annuity contract under sub-paragraph (e) of section 431B(2) for an equivalent contract with another insurer, the new contract continues to qualify for ‘pension business’.

14. Paragraph 2 makes a number of amendments to the conditions in section 590 Taxes Act 1988 as detailed below.

15. Sub-paragraph (1) extends the sole purpose test to cover rights transferred to an ex-spouse as a result of the Welfare Reform and Pensions Bill. This paragraph amends the requirement in subsection 590(2)(a) that an approved retirement benefits scheme must have as its sole purpose the provision of benefits for service as an employee.

16. Sub-paragraph (2) inserts a new subsection (aa) to subsection 590(2) which lists the categories of people for whom a mandatory approved scheme may provide benefits. As well as an employee, and his or her widow/widower and dependants this list includes an ex-spouse and his or her widow/widower and dependants.

17. Sub-paragraph (3) amends subsection 590(3) by deleting existing sub-paragraph (c) and inserting three new subsections. Subsection 590(3) sets out the current prescribed conditions which a retirement benefits scheme must satisfy if it is to secure tax approval under this section.

18. New subsection (ba) requires the benefits provided for an ex-spouse or for the widow/widower of an ex-spouse to satisfy the conditions in the new subsection 590(3A).

19. New subsection (bb) limits the maximum benefits payable to an employee scheme member to those which he or she could have had under the retirement benefits scheme if there had been no pension debit under the Welfare Reform and Pensions Bill.

20. New subsection (c) confirms that a retirement benefits scheme applying for mandatory approval may provide only the benefits specified in subsections 590(3)(a), (b) and (ba).

21. Sub-paragraph (4) amends subsection 590(3)(d) to relax the present restrictions on surrender, commutation and assignment of a pension. This is necessary so that retirement benefits schemes can implement a pension sharing order or provision under the Welfare Reform and Pensions Bill. It also allows for the exercise, by an ex-spouse, of an option to commute a pension if appropriate.

22. Sub-paragraph (5) inserts a new subsection (da) to subsection 590(3) to limit the amount of tax-free lump sum which may be taken, by an employee on retirement, following a pension share to 2.25 times the pension payable to him or her in the first year. Currently, an employee scheme member may exchange part of his or her pension on retirement for a tax-free lump sum not exceeding three eightieths of final remuneration for each year of service up to a maximum of 40 years. It is appropriate that if the pension is shared, so too should any commutable lump sum. This change will provide a simple way to ensure that the total tax-free lump sum payable is shared fairly within, broadly, the normal limits.

23. Sub-paragraph (6) inserts new subsection 590(3A) which sets out the prescribed conditions for the benefits which may be provided for an ex-spouse, namely a pension payable within the age range 60 to 75 part of which may be commuted for a lump sum. On death of an ex-spouse pensions may be paid to his or her widow/widower and dependants. These broadly mirror the current provisions in subsection 590(3)(a) to (d) which prescribe the benefits for an employee scheme member.

24. Sub-paragraph (7) extends subsection 590(4) by adding new subsection (3A) to the list of subsections which detail the prescribed conditions.

26. Paragraph 3 makes two amendments to the provisions in subsection 591(2) Taxes Act 1988, for the approval of a retirement benefits scheme under the Board of Inland Revenue’s discretion. Sub-paragraph (a) updates the existing subsection 591(2)(b) to include widowers. The present provision allows for pensions to be provided for a widow, children or dependants in the event of death in service of an employee. Sub-paragraph (b) inserts a new subsection 591(2)(ba) to broadly mirror the provisions of subsection 591(2)(b) in the event of death of an ex-spouse before the pension from the pension credit rights comes into payment. This will enable death benefits to be paid to a surviving spouse or dependants of an ex-spouse.

27. Paragraph 4 updates subsection 595(5) Taxes Act 1988 by extending it to include a husband and a widower.

28. Paragraph 5 inserts new subsections 4(a) and (b) to section 596 Taxes Act 1988 to prevent an employee claiming tax relief under the provisions of subsection 596(3) for a pension debit in favour of an ex-spouse as a result of the pension sharing provisions. The present provision allows an employee scheme member tax relief from an earlier tax charge under section 595 Taxes Act 1988 if the promised payment is not made as previously expected. The change will ensure that the tax charge will hold good where a payment has been made to an ex-spouse from pension sharing under the Welfare Reform and Pensions Bill.

29. Paragraph 6 amends subsection 596A(8)(c) Taxes Act 1988 by adding ex-spouse to the list of recipients who may receive a tax-free lump sum if the circumstances are such that a lump sum from a non-approved retirement benefits scheme would be tax free.

30. Paragraph 7 makes three amendments to section 599 Taxes Act 1988. Sub-paragraph (1) amends subsection 599(1) to make it subject to subsection (1A) and inserts in section 599 the following new subsections:

(1A) disapplies existing paragraph (a) of section 599(1) and the words following paragraph (b) of section 599(1) in circumstances where an employee scheme member’s pension, in whole or in part, is affected by a pension sharing order or provision under the Welfare Reform and Pensions Bill. The effect of this change is to allow, in the circumstances here, the calculation of the employee scheme member’s lump sum to match the basis in subsection 590(3)(da) Taxes Act 1988;

(1B) applies to retirement benefits schemes which contain a rule which permits commutation of the entire pension for a lump sum in special circumstances. It allows a tax charge to be raised where an ex-spouse commutes part or all of the pension for a lump sum under this particular rule rather than under the normal commutation rule;

(1C) makes it clear that any pension arising from ex-spouse pension credit rights is ignored when considering commutation of pension as an employee scheme member;

(1D) provides for any pension as an employee scheme member to be ignored when considering commutation of pension arising from ex-spouse pension credit rights;

(1E) makes it clear that new subsections (4B) and (4C) of section 590 Taxes Act 1988 (they provide for separate treatment under a retirement benefits scheme, of benefits as an employee scheme member and benefits from ex-spouse pension credit rights) apply equally to subsections (1C) and (1D) of this subsection.

Sub-paragraph (2) is the final amendment in this paragraph and amends subsection (6) to section 599 to cross refer to the new subsection (1B).

31. Paragraph 8 amends section 600 Taxes Act 1988. Sub-paragraph (1) amends subsection 600(1) to bring an ex-spouse within the scope of this section and sub-paragraph (2) amends subsection 600(2) to extend the charge to tax to include payments to and for the benefit an ex-spouse. This section provides for a charge to tax to be made on payments from a retirement benefits scheme which are not expressly authorised by the rules of the scheme.

32. Paragraph 9 makes two amendments to section 611 Taxes Act 1988. Sub-paragraph (1) amends subsections (3) and (4)(b) of section 611 to replace the words "employees" and "employee" with the words "scheme members" and "scheme member" respectively. Sub-paragraph (2) inserts a new subsection (6) in section 611 to include a definition of "scheme member" which encompasses both employees and ex-spouses.

Both these changes are consequential to the amendments to section 590 Taxes Act 1988 which permit the inclusion of ex-spouses as scheme members.

33. Paragraph 10 amends section 612 Taxes Act 1988 in three ways. Sub-paragraph (1) amends the definition of "relevant benefits" in subsection 612(1) to include rights acquired as a result of the pension sharing provisions. Sub-paragraph (2) amends subsection 612(2) by extending it to include ex-spouses of employees. Sub-paragraph (3) inserts new subsection (2A) into section 612 which explains the meaning of employer in subsection 612(2). All these are consequential amendments arising from the pension sharing provisions in the Welfare Reform and Pensions Bill.

34. Paragraph 11 amends subsection 615(6)(b) Taxes Act 1988 by extending the sole purpose provision to allow benefits to be provided for an ex-spouse under the scheme out of rights transferred from a scheme member under the pension sharing provisions in the Welfare Reform and Pensions Bill.

35. Paragraph 12 makes amendments to the personal pension scheme provisions in 634, 634A and 635 Taxes Act 1988 to reflect the pension sharing provisions under the Welfare Reform and Pensions Bill. Sub-paragraph (1) amends subsection 634(6) to allow an annuity to be assigned or surrendered to give effect to a pension sharing order or provision. Sub-paragraph (2) amends subsection 634A(6) to allow a right to income withdrawals to be assigned or surrendered to give effect to a pension sharing order or provision. Sub-paragraph (3) amends subsection 635(5) to allow a right to a lump sum to be assigned or surrendered to give effect to a pension sharing order or provision.

36. Paragraph 13 introduces a new subsection (3A) to section 636 and amends subsection 636(10) Taxes Act 1988. Sub-paragraph (1) inserts new subsection (3A) which explains what is meant by the highest annual amount of annuity in subsection 636(3) in the context of pension sharing provisions under the Welfare Reform and Pensions Bill. Currently subsection 636(3) sets a limit on the amount of survivors’ annuities that may be paid on the death of a personal pension scheme member. Broadly these annuities may not exceed the annuity paid to the member or (where death occurred before the annuity came into payment) would have been payable to the member had the annuity been bought on the day before the member died. The effect of new subsection (3A) is that where a member’s annuity has been reduced as a result of a pension sharing order or provision the limit on the survivors’ annuities is linked to the reduced amount after effect has been given to the pension debit. Sub-paragraph (2) amends subsection 636(10) to allow an annuity to be assigned or surrendered to give effect to a pension sharing order or provision under the Welfare Reform and Pensions Bill.

37. Paragraph 14 amends subsection (7) of section 636A Taxes Act 1988 to allow a right to income withdrawals after death of member to be assigned or surrendered to give effect to a pension sharing order or provision under the Welfare Reform and Pensions Bill.

38. Paragraph 15 makes two amendments to section 644 Taxes Act 1988. Sub-paragraph (1) inserts new subsection (6EA) to make it clear that, where a person would be in receipt of pension benefits but for a pension sharing order or provision, he or she would be deemed to be in receipt of those benefits for the purposes of subsections (6A) to (6E) of that section. The effect of this provision is to maintain the principle that earnings which are not otherwise pensionable under a personal pension scheme cannot become pensionable just because of a pension sharing order. Sub-paragraph (2) makes three amendments to subsection 644(6F). The first brings in a cross reference to new subsection (6EA), whilst the second and third amend sub-paragraphs (c) and (d). The effect of these is to ensure that the rights acquired under a pension sharing order or provision under the Welfare Reform and Pensions Bill are not taken into account in applying the provisions of subsections 644(6A) to (6EA). The current provisions set out the circumstances where certain earnings of an individual with an existing pension entitlement do not qualify to be pensioned under a personal pension scheme. These amendments prevent the earnings of an individual from being disqualified under a personal pension scheme solely because he or she has an entitlement to ex-spouse pension credit rights.

39. Paragraph 16 inserts new sub-paragraph (f) to subsection 657(2) Taxes Act 1988. The effect of this is to exclude ex-spouse pension credit annuities from the tax treatment afforded to purchased life annuities in circumstances where the original source of the ex-spouse pension credits rights does not qualify for purchased life annuity treatment.

40. Paragraph 17 inserts new section 659D Taxes Act 1988 to include two new definitions. Subsection (1) defines an "ex-spouse" for the purposes of Part XIV Taxes Act 1988 and subsection (2) defines a pension sharing order or provision by cross referring to the relevant section of the Welfare Reform and Pensions Act 1999.

41. Paragraph 18 details the rules for commencement of the provisions under this Schedule.

42. Sub-paragraph (1) defines the first appointed day and the second appointed day for the purposes of this paragraph as such day as appointed by the Treasury in an order. It is intended that the first appointed day will be the later of the enactment of this Finance Bill and the Welfare Reform and Pensions Bill.

43. Sub-paragraph (2) enables different dates for the second appointed day if for any reason the pension sharing provisions under the Welfare Reform and Pensions Bill do not uniformly come into force throughout the United Kingdom.

44. Sub-paragraph (3), which is subject to sub-paragraph (4) below, provides that on or after the first appointed day, the approval or continuing approval of a retirement benefits scheme (whenever made or approved) is dependent on the inclusion of the provisions in paragraphs 2 and 3(b) of this Schedule. The effect of this is that any retirement benefits scheme which seeks approval (or continued approval in the case of an approved scheme which is being amended) on or after this day must include the pension sharing provisions in their rules in anticipation of them coming into force on the second appointed day.

45. Sub-paragraph (4) provides for subsections 590(3)(bb) and (da) Taxes Act 1988 to be disapplied in some circumstances. This applies to cases where the approval of a retirement benefits scheme (i.e. one approved before the first appointed day) is being reconsidered because of amendments to the scheme rules in the period between the first appointed day and the second appointed day. This will protect such a scheme from having its approval withdrawn solely on grounds that the requirements of subsections 590(3)(bb) and (da) (which are pension sharing provisions which do not come into force until the second appointed day) are not reflected in the scheme rules.

46. Sub-paragraph (5) overrides the rules of all retirement benefits schemes which were approved before the first appointed day and continue to be so approved on and after the second appointed day. The effect of this override is that once the pension sharing provisions come into force these retirement benefits schemes will be deemed to have the provisions of subsections 590(3)(bb) and (da) Taxes Act 1988 in their rules in so far as they do not already do so. This means that the scheme rules need not be amended at the time the changes come into force. This override is subject to such exceptions as may be prescribed in the regulations provided for in subparagraphs 18(10) and 18(11) below.

47. Sub-paragraph (6) provides for paragraph 6 (lump sums provided under non-approved schemes) to apply to any lump sum paid to an ex-spouse on or after the second appointed day.

48. Sub-paragraph (7) brings paragraph 8 (charge on unauthorised payments) into effect for payments, made to or for the benefit an ex-spouse on or after the second appointed day, which are not expressly authorised by the rules of the retirement benefits scheme.

49. Sub-paragraph (8), which is subject to sub-paragraph (9) below, provides that, on or after the first appointed day, the approval or continuing approval of a personal pension scheme (or any arrangements made under it), whenever made or approved, is dependent on the application of the provisions in paragraphs 12 to 14 of this Schedule.

50. Sub-paragraph (9) provides for section 636(3A) Taxes Act 1988 to be disregarded where personal pension schemes (or any arrangements made under them) approved before the first appointed day are being amended in the period between the first appointed day and the second appointed day.

This will protect such personal pension schemes (or any arrangements made under them) from having their approval withdrawn solely on grounds that the requirements of section 636(3A) Taxes Act 1988 (which is a pension sharing provision which does not come into force until the second appointed day) are not reflected in the scheme rules.

51. Sub-paragraph (10) allows the Board of Inland Revenue to apply the provisions of the Schedule to retirement benefits schemes approved before the first appointed day subject to any exceptions, exclusions or modifications prescribed by regulations (see paragraph 47 above).

52. Sub-paragraph (11) provides for the regulations relating to retirement benefits schemes mentioned in sub-paragraph 10 above to include such incidental, supplemental, consequential and transitional provision as the Board thinks fit.

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53. The tax approval system relating to pension schemes (both retirement benefit schemes of employers and personal pension schemes) gives very favourable tax treatment if certain conditions are met concerning the amount, form and timing of the benefits to be paid to scheme members. The purpose of the tax reliefs is to encourage the provision of pensions in retirement for scheme members.

54. The legislation governing the tax treatment of retirement benefits schemes and personal pension schemes is found in Chapters I and IV of Part XIV of ICTA as amended by subsequent Finance Acts.

55. The provisions in section 590 Taxes Act 1988 set out certain basic conditions which entitle a retirement benefits scheme to approval if it meets those prescribed conditions. These provisions are supplemented with discretionary powers in section 591 Taxes Act 1988 (restricted by regulations) given to the Board of Inland Revenue to enable tax approval of retirement benefits schemes which do not fully meet those conditions. The vast majority of retirement benefits schemes are tax approved under these discretionary powers and are commonly known as discretionary approved occupational pension schemes.

56. Currently, courts cannot generally order the sharing of pension rights as part of achieving an equitable financial settlement on the ending of a marriage by divorce or annulment. The present provisions allow courts to take pensions into account in broadly two ways. The value can be taken into account and offset against other assets in arriving at the financial settlement or the actual pension or lump sum can be earmarked for an ex-spouse so that when it comes into payment the specified amount can be paid direct to the ex-spouse. The drawback to an earmarking order on a pension or lump sum is that the payments are dependent on the circumstances of the scheme member. So if he or she dies before the benefit comes into payment the earmarking order becomes ineffective.

57. The Government wants to give divorcing couples the option of pension sharing to ensure that assets can be divided fairly and so make it easier for divorcing couples to achieve financial independence through a clean break financial settlement. A consultation paper which included draft legislation (social security, family, and matrimonial law together with tax clauses) was published for consultation in June 1998. The revised draft provisions reflect the outcome of that consultation where the Government thought it appropriate.

58. Pension sharing will apply to all types of pension arrangements other than the basic State pension. The proposed amendments to the tax rules coupled with necessary changes to social security, family and matrimonial law, will ensure that a tax approved scheme can implement pension sharing when it is required to do so under the Welfare Reform and Pensions Bill