With effect from 6 April 2012, schemes will no longer have to make special provision in relation to protected rights and the majority of the legislation relating to them will fall away. At the eleventh hour, the Government has highlighted an issue in relation to the abolition of protected rights which trustees and their scheme administrators should be aware of.

The issue

Currently, where a member leaves with less than 2 years pensionable service, most schemes will provide for a short service refund lump sum of the member's own contributions (unless the member has been in the scheme for over three months and opts for a transfer). Such a lump sum must extinguish all of a member's benefits under the scheme. However, there is an exception where benefits cannot be extinguished because legislation prevents it; this currently covers the position where schemes must retain a member's protected rights. After 6 April 2012, there will no longer be a statutory requirement to provide protected rights and therefore this exemption will no longer apply. This means that where a member leaves with less than 2 years service and had protected rights, careful consideration will need to be given as to the benefits to be provided.

What are the options?

Where scheme rules can be interpreted post-abolition as allowing a refund of member contributions and not requiring any former protected rights to be retained in the scheme, there will not be a problem as a short service refund lump sum can be paid which extinguishes a member's entitlement under the scheme.

Problems arise where scheme rules cannot be interpreted from 6 April 2012 as allowing the refund of former protected rights without amendments being made. In such cases, the rules may require former protected rights to be retained in the scheme and also require a short service refund lump sum to be made. However, any lump sum which represents only part of the member's rights under the scheme will no longer be an authorised payment for tax purposes (as there will no longer be any exemption available) and it will attract charges accordingly.

HMRC have issued a statement confirming that they are aware of this issue and that they are intending to consult on regulations which will allow affected schemes to "pay a partial refund without incurring unauthorised payment charges". They anticipate that such regulations will come into force in "summer 2012" and "apply for a transitional period, by the end of which affected schemes should have been able to make the rule changes necessary to comply with the existing tax rules for short service refund lump sums" but they will not be retrospective. This means that there will be a period between 6 April 2012 and the regulations coming into force during which partial refunds cannot be made as authorised payments. As a result, HMRC advises that "Schemes may wish to check their scheme rules to see if they are affected. They may wish to consider delaying such payments until they can either change their rules or take advantage of the new tax rule once the regulations have come into force".

What is a member contribution?

Schemes also need to give careful consideration as to what should properly be treated as a member contribution post-abolition and what can therefore be included in a short service refund lump sum. HMRC has given some guidance on this in Countdown Bulletin No. 6 which says that the "minimum payments from the employer to the scheme relating to the employee contribution are member contributions as is any employer contribution that is recovered from the employee together with the HMRC rebate. Any employer contribution not recovered from the employee would not be a member contribution for our purposes".

What should you do next?

If you are not clear what your rules will require after the abolition of protected rights and whether this will have any effect on your scheme or not, you should clarify the position and consider delaying the payment of any short service refund lump sums where the member leaves on or after 6 April 2012 until the issue has been resolved.

Should you wish to discuss this issue further, please speak to your usual contact at CMS Cameron McKenna.

HMRC's full statement can be found here.

Countdown Bulletin No. 6 can be found here.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 27/03/2012.