Employee Benefit Trusts – An Update
The purpose of these notes is to provide information on the current issues regarding Employee Benefit Trusts, considering in particular possible challenges by HMRC.
What is an EBT?
An EBT is a trust set up by an employer for the benefit of employees (including directors) and former employees, their spouses and dependants.
Such trusts may be established within or outside the UK under UK or foreign law. An EBT is normally funded by an initial contribution (usually nominal) plus a series of periodic contributions. Such contributions are at the discretion of the employing company.
Tax and NIC Position of Benefits to Employees
Cash payments out of the Trust will be liable to income tax and national insurance contributions. The Trustees (or the company) would have to operate PAYE on such payments.
The benefit-in-kind provisions will apply where instead of cash or “readily convertible assets” being transferred to the employee, a benefit-in-kind is made available. Such benefits-in-kind are, of course, liable to income tax and Class 1A (Employer’s) NIC.
The benefit of an interest free loan is calculated by reference to the Inland Revenue’s official rate of interest, which is presently 4.75% per annum. Therefore, the tax payable on an interest free loan of £20,000 would be calculated thus:-
£20,000 x 4.75% = £950 x 40% = £380.
For a basic rate taxpayer, the tax liability would be £190.
HMRC approach
There have been two recent cases involving EBTs – Dextra Accessories Limited and Sempra Metals Limited.
In both cases, in addition to seeking to deny corporation tax relief on the contributions, HMRC have argued that allocations or loans to employees are subject to PAYE/NIC. The Special Commissioners in Sempra agreed with the previous decision in Dextra that loans made by the EBT were neither emoluments nor earnings. Appeals due to be heard in the High Court in March 2009 were withdrawn but HMRC are of the opinion that this means that the issues are unresolved and they say they will continue to challenge cases on the basis that PAYE/NIC is due, although we have not seen this as yet in practice. It is difficult to understand the justification of HMRC’s stance considering the decisions in Dextra and Sempra.
Inheritance Tax
On 11 August 2009 HMRC issued Revenue & Customs Brief 49/09 “Inheritance Tax on contributions to Employee Benefit Trusts.”
This publication confirms what we have known for some time now about HMRC’s views on certain relieving provisions in the Inheritance Tax Act, for example its views on s10 IHTA (no gratuitous intent) and s12 IHTA (relief only available if a corporation tax deduction is allowable for the tax year in which contributions are made).
The first point to make is that IHT becomes a non-issue if contributions by close companies fall within the shareholders “nil rate bands” for IHT (currently £325,000).
Where contributions exceed that level (when apportioned to individual shareholders pro-rata to their shareholdings), our Trust Deed excludes shareholders from benefitting from the EBT except in the form of benefits liable to income tax. Such benefits expressly do not include interest free loans. However, we take the view (endorsed by our Tax Counsel) that there is nothing to prevent shareholders receiving interest bearing loans. Controversially, HMRC are now saying that in their view the granting of a commercial loan to a shareholder represents a benefit which removes the relief afforded by s13(4) IHTA 1984. It is difficult to see how a loan at a commercial rate of interest can be a benefit. Furthermore, HMRC are saying that the assignment of funds by the EBT trustee to sub-trusts for their (shareholders) benefit also removes the s13(4) protection. It is even more difficult to see how the assignment of funds to a sub-trust can be a benefit.
I shall be discussing the merits of HMRC’s views with our Tax Counsel and I will report further in due course. In the meantime my advice would be to keep contributions within shareholders nil rate bands. Also, for Trusts recently established I would defer creation of sub-trusts but formally allocate funds to individuals to satisfy UITF 32 and remove the EBT assets from the company’s balance sheet.
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