Nick Wallis, April 2012
Nick Wallis is Corporate Tax Director for Smith & Williamson in London.
One of Scotland’s top professional football clubs, Glasgow Rangers, was forced into administration by HMRC, which is trying to recover at least GBP49 million in tax and penalties resulting from Rangers’ use of employment benefit trusts (EBTs) to pay players. With EBTs put on the spot, several English clubs are also in serious tax trouble. The below is one of two features about this matter. Read the other feature here
ABOUT THE AUTHOR: Nick Wallis is Corporate Tax Director for Smith & Williamson in London
How did ‘disguised remuneration’ come to mean ‘employment income paid through third parties’? What, in simple terms, has been going on? If you are a highly paid employee, and you have bought your yacht and skiing chalet, you will not have a current need for money. In other words, there is no point in being paid until you need the cash because you will only be taxed. So there is no point in drawing taxed salary and paying tax. Moreover, the result will be even better if the undrawn pay can be invested in the meantime. From the employer’s point of view, once the proposed remuneration has been expensed, its actual destination is broadly a matter of indifference provided the PAYE and National Insurance contributions position is indemnified.
This basic idea came from the earlier planning in this area: that ‘tax deferred is tax saved’. However, HMRC sought to oppose this approach on the basis that it did not achieve what it refers to as ‘fiscal symmetry’: an employer should only get a deduction for remuneration once it has been paid to the employee and PAYE has been paid.
The next development of tax planning in this area was to enable the employee to access the value set aside for them without paying income tax. In simple terms, this was achieved by the trustees of an employee benefit trust (EBT) lending the money, either interest free or at interest, for an indefinite period. This completed the perfect world for the taxpayers with a deduction for the employer and no income tax for the employee (plus inheritance tax advantages) and it is easy to see how third-party arrangements became big business.
Various developments in the accounting world made this treatment slightly more difficult to achieve in certain circumstances, in particular the introduction of UITF 32 (accounting for EBTs and other intermediate payments), but these issues did not slow down the planners. Unsurprisingly, HMRC started to challenge these arrangements more robustly and this led to two important results: first, the seminal case of Dextra v Macdonald and second, the new legislation in Finance Act 2003 sch24.
Dextra v Macdonald
Dextra was a classic EBT planning case. The employer paid a large amount into an EBT, which was promptly on-lent to the employee while the employer claimed the relevant tax deduction. The trustees testified in court that the loan was indeed a loan, and quite properly, it was also found that in the law hitherto, a loan is a loan and not remuneration (although, of course, interest forgone can be a benefit-in-kind).
When the case was first heard, HMRC lost before the Special Commissioners and it did not pursue its case against the employee that he had received pay instead of a loan. So this point was never heard by the higher courts and it was presumed that HMRC did not appeal because it thought it would lose. The upshot is that although HMRC persisted in maintaining that loans can in effect represent pay, the Commissioners said otherwise. Dextra may not have the status of legal precedent on this point, but it looms over cases involving loans and is invariably cited in taxpayers’ favour by planners in this area.
The second leg of the case concerned the availability of a deduction for the employer for the contribution to the trust. Since 1989, there has been legislation to prevent a deduction for employers for emoluments (as they were called) unless, and until, they were paid. Broadly, this included situations where payments were made to intermediaries ‘with a view to their becoming emoluments’ (i.e. paid as remuneration). However, there were indications that HMRC accepted that amounts paid to a trust might represent other benefits in due course at the discretion of the trustees.
Dextra may not have legal precedent, but it looms over cases involving loans
In this case, the Court interpreted that crucial phrase ‘with a view to…’ as meaning ‘there was a realistic possibility’, which simply denotes likelihood, regardless of intention. While the case was still proceeding, HMRC decided to act, perhaps in anticipation of losing the case. The Finance Act 2003 sch24 (now included in Corporation Tax Act 2009 part 20 ch1) applied to payments into employee benefit arrangements and the Finance Act 1989 s43 was also redesigned to cover the case where the employer made a suitable provision without making a payment to a third party.
The overt message of this legislation could not be clearer. Fiscal symmetry was to be enforced and an employer could not have a deduction until the employee had a taxable receipt. Planners therefore assumed that provided the fiscal symmetry rule was obeyed, there was no problem if loans, or similar non-taxable benefits, were taken by beneficiaries. It was thought that the lack of deduction was a fair swap for lack of taxability on the employee.
The original drafting of sch24 was not watertight, resulting in planners continuing to draw up schemes to avoid fiscal symmetry. In subsequent Finance Acts the schedule was duly tinkered with to try to make sure it did apply. HMRC also tightened the screw by looking at the position of close company transfers for inheritance tax. This was followed by a reawakening of interest in employer-funded retirement benefit schemes being used as top-up pension arrangements following the changes to pensions tax relief, notably in the Finance Act 2009.
HMRC seems to think that even if trustees simply earmark funds it is as good as pay
There were numerous other ideas doing the rounds. These included inventing employments with EBTs attached, using the employer company as trustee, getting banks to create off-the-shelf trusts so the company could purchase a trust interest, thus bypassing the specific rules about contributions to an EBT, and so on.
HMRC persevered. In addition to introducing counteracting legislation, it issued a series of other publications, including Spotlights 5 and 6 and ‘briefings’, which set out the pitfalls in this planning. It seems these were designed, in part, to discourage these planners. They also indicated just how far apart the views of mainstream practitioners and HMRC were, particularly over what constituted receipt for remuneration purposes. HMRC seemed to think that even if the trustees simply earmarked the funds it was equivalent to a payment and a loan was as good as pay.
There appeared to be no end to this toing and froing and, indeed, this will continue for some time because arrangements put in place before the disguised remuneration legislation will need to be settled one way or another.
Although fair warning of the December 2010 legislation was given, certain provisions took immediate effect, while others were delayed until April 2011.
The legislation is designed to catch various mischiefs where it is ‘reasonable to suppose that in essence’ what is going on is the provision of recognition or reward or loans. This use of woolly phraseology is arguably deliberate.
Have we given up on clear and concise drafting of legislation? Perhaps so. It is almost as if the legislation is saying ‘we know what we don’t like; we can’t describe it, but we’ll know it when we see it, so don’t do it’. In December 2004, the then Paymaster General, Dawn Primarolo, said ‘employees should pay the right amount of tax’, but as we will see the new rules could mean employees paying tax on a nil benefit: hardly ‘the right’ amount.
The catch-all nature of the legislation means detailed exceptions are needed to permit various activities usually operated via third parties, such as ordinary share plans for employees, ordinary employee benefit packages like bus pass loans, and registered pensions. It’s a strange new world where providers of such straightforward arrangements will now have to check in detail to ensure they are not breaking the rules.
It is not enough to fall within the exceptions permitted; it must also be demonstrated that no tax-avoidance motive is present, as underlying this legislation is effectively a general anti-avoidance rule on just about every activity mentioned.
At a time when the government is promoting simplification and the removal of regulatory burdens on business, it is disappointing that the new rules are so ill-defined. The approach taken has been so Draconian and the weapon fashioned so blunt that it is often difficult to see what is being aimed at. It’s a brave person who tries to discern the spirit of the legislation, if indeed there is one.
The trouble is, if we cannot exactly articulate the problem, we cannot exactly articulate the solution. This may in part be the reason for such excessive paperwork. How much better – if it could be achieved – for this legislation to be reduced to a series of clear, understandable rules? And this can be achieved with clear policy and concise drafting. Let’s not do it this way again.
New rules unfair and inconsistent
About the author: Wendy Walton TEP is STEP UK Technical Committee Chair. The full comment, which was submitted on 9 February 2011, is online at www.step.org/disguisedremuneration
STEP’s UK Technical Committee welcomed the chance to comment on the disguised remuneration ‘Employment income through third party’ draft legislation, published on 9 December 2010, which is intended to comprise a new Part 7A of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA).
‘We believe that the provisions relating to earmarking are unfair and unworkable. We strongly urge the government to withdraw these provisions and that they should be replaced with measures that only impose tax when a legal right to money or assets is obtained by the employee.
‘We believe that the impact of these measures, even if the earmarking provisions are removed, will act as a disincentive for businesses to enter into genuine employee benefit packages for those employees who generate wealth for UK businesses and therefore the UK economy.
‘This legislation is not consistent with other tax legislation relating to benefits received by individuals from companies or trusts. We strongly urge the government to rethink its approach in this regard and to introduce, instead, a more logical, consistent and fair set of rules. This should be based on the principle that individuals should not be taxed unless they have a legal right to an asset or a sum of money.
‘Furthermore, the basis of taxation should be on the benefit actually received and therefore the provisions relating to the taxation of loans and the provision of assets should be substantially revised. The treatment under these provisions should mirror those for the taxation of benefits from non-remuneration trusts and/or benefits from employers when provided directly.
‘The rules should exclude all normal and genuine employer incentive arrangements and any pensions which are already taxable under ITEPA. All pre-existing schemes should be excluded, in particular pre-A Day corresponding schemes as well as pre- and post-A Day s615(6) schemes.’