Broadly speaking, if they are not resident in Scotland, the amount of the annual allowance excess is added to the top part of the person’s taxable income. This is purely to find the tax rate to use for the charge. It’s not treated as income for calculations of other tax implications.

It is also worth noting that the annual allowance excess amount is not added to taxable income for threshold income or adjusted income calculations required as part of the tapered annual allowance sums.

Based on the rest of UK rates, the part of the excess that falls:

• below or within the basic rate band is taxed at 20 per cent
• within the higher rate band is taxed at 40 per cent
• in excess of the additional rate threshold is taxed at 45 per cent. 

Normally, the individual concerned notifies and pays the annual allowance charge through their self-assessment. However, from 11 August 2011, the ability to pay a charge from pension benefits was introduced and is known as ‘scheme pays’.

What is ‘scheme pays’?

When the annual allowance changes were made in April 2011, it became apparent that more people would be affected by an annual allowance charge.

As a result, two main actions were taken:

• The introduction of carry forward. 
• Allowing people to pay the charge from their pension benefits.

This can be on a mandatory or voluntary basis.

HMRC’s guidance is very clear. The liability for an annual allowance charge normally rests with the individual.

However, the Finance Act 2011 allows an individual to opt for the pension scheme administrator to be jointly liable for the tax charge. This is known as ‘mandatory scheme pays’. 

Where an individual has an annual allowance charge of over £2,000 – and their pension input amounts for that scheme exceed £40,000 – they can ask their pension scheme to pay the charge for them in return for an actuarial equivalent reduction in the value of their pension.

The pension scheme may choose to pay the annual allowance charge for a member when asked, even if they do not have to. This is known as ‘voluntary scheme pays’.

What planning could you consider? 

If you have clients who are impacted by the tapered annual allowance, there are two main planning considerations for you to consider in order to alter the potential impact of the tapered allowance. These can significantly reduce potential tax liability. 

These are: 

• Making contributions to a relief at source pension.
• Using carry forward of any earlier years' unused annual allowances.    

Contributing to a relief at source pension can reduce the threshold income.

This is particularly useful if it can reduce the threshold income below £200,000 – and therefore fully negate any tapered annual allowance being applied even if the threshold income exceeds £240,000.   

If clients have breached the tapered annual allowance, you might also consider whether to carry forward unused relief from earlier years.

That way you can reduce or absorb the excess amounts over and above the tapered annual allowance. 

Richard Cooper is a business development manager at the London Institute of Banking and Finance