These are: that they must follow a carefully structured series of steps referred to as structured finance arrangements (SFAs); the payments to the pension scheme from the structure are made at least annually and do not increase by more than 5% per year or the increase in RPI; the term of the structure is no more than 25 years; and there are no backend loaded bullet payments.
Rules normally require a UK taxpaying company to spread that tax deductible sum over four years, but the benefit of the new legislation is because it has been paid in full it can claim a deduction on the full amount of the contribution from day one.
“That is a very significant benefit,” explains Fripp. “Provided you structure these in the right way, in a smooth amount that does not exceed more than 5% a year, this can bring an acceleration in tax deduction and it is not regarded as aggressive by any of the tax authorities.”
Payback time
In addition to the tax benefit, ABF deals allow employers and trustees to fund deficits in year one, but beneath the surface a series of payments are promised which extend over a longer period so it is cash conserving for companies and deficit-solving for trustees.
For example, if a deal comprises £8m promised over 20 years, it would produce a £100m real asset which reduces the deficit by that amount on day one (it is viewed as £100m rather than £160m to allow for the changing value of money over time). So even though only £8m is paid through cashflow, the scheme describes itself as £100m better off.
But under the UK regulatory regime it is difficult for a UK company, unless under severe distress, to pay off its deficit over a period of more than 10 years, so why should trustees agree to what is essentially a longer timeframe?
According to Fripp, it is because good quality, bankruptcy-remote assets are placed in a structure which provides additional comfort to trustees in the event of insolvency.
“While the trustees are invited to take a longer repayment period over which to have their deficit repaired, they do so with the additional comfort of assets being placed closer to them in the event of insolvency,” says Fripp.
However, The Pensions Regulator (TPR) executive director for defined benefit regulation Stephen Soper warns: “Where those contingent assets wholly or partly replace a standard recovery plan for the scheme, trustees need to understand, and to be able to explain to us, whether the structure is actually a better alternative for scheme members. This includes comparing the period of time over which the scheme’s deficit will be met.”
Soper believes it is important trustees assess the genuine value of the structure to the scheme. “In some scenarios, such as employer insolvency, the underlying assets might even prove worthless,” he adds.
Due diligence
Before undertaking an ABF deal, trustees need to be sure the investment is not one which offends the employer-related investment (ERI) regulations. It is a criminal offence for trustees to invest in ERIs and is something advisory firms overcome from a technical perspective by structuring the SPV to make sure it does not fall within the definition of an ERI.
Mercer’s Lee believes the main risk for these structures is that UK legislation does not reflect the European legislation when it comes to ERI because the language is subtly different. UK language says investment in a partnership is not ERI whereas in the EU this is less clear.
“That is why TPR seems to go hot and cold on these structures,” he says. “It is driven by a fear that the EU will turn round and say, ‘the UK has not implemented the legislation appropriately’. That is why trustees should be very focused on following TPR’s guidance so they can protect themselves against this position.”
Elsewhere, trustees should be aware of aggressive ABF proposals suggested by the company’s advisers. Lee has seen deals rejected, such as intra-company loans, which are just a way of spreading a payment of money due quite soon over a longer timeframe.
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