What lies beneath - Putting employee benefit trusts in the spotlight
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.
For many years, employers in the Crown Dependencies have rewarded staff in tax-efficient ways through trusts or other intermediaries, such as employee benefit trusts (EBTs). But HMRC does not support this. It has long been an established practice to enquire into returns submitted by employers that include a deduction for contributions made to such arrangements, and to challenge what it perceives to be any failure to operate PAYE on those payments. This can leave the employer and employee’s positions unclear.
Although the landscape has changed, many tax professionals still disagree with HMRC’s view, as set out in its ‘Spotlight 5’ advice, that ‘at the time the funds are allocated to the employee or their beneficiaries, those funds become earnings on which PAYE and National Insurance Contributions (NIC) are due and should be accounted for by the employer’. One consequence is that HMRC is now dealing with a large backlog of enquiries, some of which have remained dormant for years.
To tackle this, HMRC launched a two-pronged assault. In a bid to clarify the law and effectively put a stop to tax-efficient rewards paid through third parties, the ‘disguised remuneration’ rules in the Finance Act 2011 became law on 6 April 2011, although they were partly retrospective with effect from 9 December 2010. To accompany this, HMRC has shown a new determination to settle open enquiries into trust-based arrangements, announcing the terms on which it is prepared to negotiate with employers to settle open cases without litigation: the ‘EBT Settlement Opportunity’ in April 2011. On first reading, there is little to entice employers, employees and trustees to the negotiating table. The Settlement Opportunity only relates to contributions made to EBTs before 6 April 2011, and while it purports to relate to open enquiries, it can be used by EBTs that are not under enquiry but want settlement and certainty regarding any UK tax treatment.
The disguised remuneration rules imposed employment taxes (PAYE and NIC) where third parties make provision for what is a reward, recognition or loan in connection with an employee’s past, present or future employment after 6 April 2011 (or on or before 9 December 2010 in the case of a loan). The rules stated that where there is former, current or prospective employment between the employee and the employer, plus an arrangement relating to the employee, and a relevant step is taken by a relevant third party in favour of a relevant person, this results in a tax charge unless there is specific exclusion.
Relevant steps include earmarking money or assets, payment of money including loans or the transfer of assets, or making assets available. Section 554(1)(b) also states that earmarking will include when money or assets otherwise start being held by the third party with a view to a later relevant step being taken, even if details of this relevant step have not been worked out or the step is never taken. The charge to tax arises when the relevant step is taken, on the value of the relevant step.
The announcement of April 2011 is split into two parts. The first part envisages settlements that are reached with HMRC within the terms of ‘EBT Settlement Opportunity’ and before a ‘relevant step’ has taken place. Broadly, this scenario is possible where any activity within the EBT has already taken place before 6 April 2011 and no ‘relevant step’ has taken place since. In this scenario, HMRC will seek PAYE and NIC at the date they were made to the trust (or some other relevant trigger date such as the creation of sub-trusts). A credit is allowed for any tax and NIC already paid on benefits in kind arising from the arrangement, and the prospect of double taxation is removed with confirmation that the employee will be entitled to a credit against a future ‘relevant step’ in respect of money held in the trust. If the trust is unwound on reaching a settlement with HMRC, there should not be any further charge to PAYE and NIC on any growth in the value of the assets held in the EBT, although other taxes may come into play (income tax and or capital gains tax) to tax the ‘growth’ element.
The second part deals with the situation where a ‘relevant step’ within the disguised remuneration legislation has been taken on or after 6 April 2011. Here, the new legislation will bite and PAYE and NIC would become chargeable at the point when the ‘relevant step’ is taken. However, HMRC is clear, for contributions made to the EBT before 6 April 2011 it will not also pursue PAYE and NIC on the same amount for the earlier period. Additionally, HMRC confirms that even if a ‘relevant step’ has been taken, if there are further sums in the trust that are not caught by the disguised remuneration legislation at the time of a settlement (e.g. no ‘relevant step’ has been taken) these sums can be still be settled under the terms of the first part of the announcement.
Key questions to consider
- Are the EBT arrangements currently under enquiry by HMRC? If so, has HMRC raised protective assessments for any years?
- What date(s) were contributions made to the EBT? Have any amounts been allocated to sub-trusts (or otherwise earmarked for particular beneficiaries)?
- What, if any, amounts of UK tax(es) have already been paid to date?
- How have the trustees invested the contributions made to the EBT? What (if any) assets have been made available to the beneficiaries?
- Who will fund any potential tax liabilities that may be agreed as part of any settlement with HMRC (i.e. employer or trustees/beneficiaries)? If the employer, should there be any gross-up?
- Is there a desire to wind up the EBT structure?
So why would an employer subject to an enquiry wish to settle on these terms? This is a good question, as a strong case can be made for many trust arrangements that PAYE and NIC will only be due when payments are made out of the trust to beneficiaries. However, there are many drivers as to why employers and beneficiaries may be willing to explore, on a ‘without prejudice’ basis, an agreement under HMRC’s Settlement Opportunity. These include (but are in no way limited to):
- Some employers do not want years of backlog and open enquiries with HMRC and the uncertainty of ongoing or future litigation risk.
- Beneficiaries want to get out of the EBT arrangement and want to explore the possibility of paying PAYE and NIC at rates below the current 50 per cent PAYE and 15.8 per cent NIC rates.
- HMRC may be out of time to recover all PAYE and NIC it argues is due (and there are no requisite protective assessments in place). This can lead to a situation where a corporation tax deduction is secured on the total contributions made to the EBT, but only part of the PAYE and NIC potentially due is actually paid under the terms of a settlement.
- Where an EBT structure is completely unwound, it is not uncommon to achieve a settlement equivalent to an effective tax rate of about 25–30 per cent of the total assets in the EBT, which can represent significant savings, particularly in view of the disguised remuneration rules where, in the future, beneficiaries may be liable to effective tax rates of 60 per cent plus.
HMRC has shown a new determination to settle open enquiries
Those who have read the announcement may have been struck by how short it is and the fact it is silent on key points, including the tax treatment for beneficiaries after the point at which PAYE and NIC is charged. HMRC has been clear that the precise terms on offer will depend on the individual facts, and this is certainly our experience.
Since April 2011, many EBT settlements have been negotiated and agreed with HMRC. In many cases extremely good settlement terms have been agreed, including some where no additional tax is due (and, in a small number of cases, repayments of taxes are due). Although to date many settlements have been agreed with HMRC with no inheritance tax (IHT) consequences, HMRC’s technical view about the IHT position has been evolving and its current position is set out in Revenue and Customs Brief 18/11. As at January 2012, typically HMRC requires IHT to be considered in all cases under the settlement opportunity. Some tax advisors consider that in many cases IHT should not be in point, so they are making representations to HMRC about certain aspects of HMRC’s current technical view, which we hope will lead to further clarity of HMRC’s approach in due course.
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