There will be very little direct involvement by payroll departments in pensions administration from 6 April 2006 when the new simplification provisions take effect. Most lump sum payments made from a "registered pension scheme" (as tax approved pension schemes are known from 6 April 2006) are not subject to income tax. One exception, however, is that the tax liabilities on trivial commutation payments must be handled under PAYE.

Pension payments are "commuted" where they are exchanged for a single lump sum payment, usually because the value of the pension is too small, or trivial, to turn into monthly pension payments.

HMRC, in its latest Pensions Tax Simplification Newsletter has provided guidance for employers and scheme providers making trivial commutation payments on or after 6 April 2006 to pensioners or to employees who would otherwise have become pensioners if the pension benefits were not being commuted. Guidance for employers is also provided in CWG2(2006) Employer Further Guide to PAYE and NICs, from page 20 onwards.

Where a scheme offers the facility of full commutation on the grounds of triviality, there are four possible types of payments:

• trivial commutation lump sums
• winding-up lump sums
• trivial commutation lump sum death benefits
• winding-up lump sum death benefits.

For such lump sums to be treated as trivial commutation payment, the conditions specified in Schedule 29 of the Finance Act 2004 must be met. For example, certain age restrictions apply, the lump sum must extinguish the member's entitlement to pension scheme benefits, and the lump sum must not exceed 1% of the standard lifetime allowance (£;15,000 for 2006/07).

Recipients of trivial commutation and winding-up lump sums are treated as having taxable pension income for the tax year in which payment is made, equal to the amount of the payment. But if, prior to the payment, the member has not become entitled to any benefits under the scheme, only 75% of the lump sum is taxable pension income. The whole of any trivial commutation lump sum death benefit and winding-up lump sum death benefit is treated as taxable pension income.

The PAYE procedures are as follows:

• Where a pensioner is already receiving pension payments when commutation occurs, the amount on which tax is due is added to gross pay. After the payment is made using the pensioner's normal tax code, a P45 is prepared showing the total of the pension payments already made in the tax year and the commutation payment. Part 1 is sent to HMRC and Parts 1A, 2 and 3 are given to the pensioner.
  
  
• Where pension payments have not yet started, the employee is set up to be paid as a pensioner and the amount of the payment on which tax is due is taxed using the emergency code on a week 1/month 1 basis. Form P46 is not completed. When the payment has been made, a P45 is prepared. Part 1 is sent to HMRC and Parts 1A, 2 and 3 are given to the pensioner.

There are no Class 1 NICs due on these lump sum payments.

As taxation of trivial commutation lump sums under PAYE may subsequently require a tax refund, HMRC has introduced an in-year tax repayment claim procedure. To ensure that recipients are made aware of the procedure, pension schemes are encouraged to send the following notice to members at the time trivial commutation lump sums are paid:

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