Author: John Forde
On 9 December 2010 the government published draft legislation designed to prevent the use of trusts and other third party structures as a means of reducing tax on employment income.
The government is particularly keen to prevent the use of employee benefit trusts (EBTs) and employer-financed retirement benefit schemes (EFRBs) for such purposes. Employers and employees that are involved with such arrangements should consider as a matter of urgency how the new rules may affect them.
The final form of the legislation will take effect from 6 April 2011 although certain aspects of it will operate retrospectively and catch steps taken between 9 December 2010 and 6 April 2011.
EBTs and EFRBs had been heavily marketed in recent years as a means to defer or avoid income tax and national insurance contributions (NICs) on employment income.
In very broad terms these structures had been used as follows. An offshore EBT or EFRB would be set up and a salary or bonus payments would be contributed by the employer without an income tax or NIC charge arising. The offshore trustees could then invest the contributions on behalf of the employee and roll-up any income and capital gains with limited or no UK tax. Tax and NICs on the employment income could essentially be deferred until any funds were transferred out of the EBT/EFRB to the employee. The eventual tax charge on extraction could itself be mitigated by making any payments in the form of a loan – in this case tax would not be payable on the total amount of the loan received but only on the value of the annual benefit received if the loan was not at a commercial rate of interest. Alternatively, in certain circumstances, there were opportunities for the funds to be extracted without any tax at all by waiting until the employee had become non-resident.
The legislation imposes new and accelerated employment tax charges where payments are made to any intermediary (not just EBTs and EFRBs) and where it is reasonable to infer that there is an intention to benefit employees or other persons connected to them. Tax charges will now arise at the moment the intermediary “earmarks” any asset (no matter how informally) for the benefit of an employee and this will apply even if at that stage the employee is not actually entitled to the asset. The new rules will not only catch the making of cash payments but also where an employee is given use of or transferred an asset (e.g. a property) or provided with a loan (tax will now also be payable on the full amount of the loan and not just the annual benefit received as before). Where the new charge has been triggered the employer will be required to operate PAYE and pay over tax to HMRC on the sums involved.
The new legislation has been drafted incredibly widely and no tax avoidance motive has to be proven for it to apply. The government’s tactic has been to draft the legislation as broadly as possible and then seek to specifically exclude particular uses of EBTs and EFRBs that they regard as acceptable. To date there are exclusions for amongst other things: steps taken under an HMRC-approved share plan (Company Share Option Plan, Share Incentive Plan or Sharesave) and those involving registered pension schemes; arrangements to grant options as Enterprise Management Incentives; the use of EBTs as “warehouses” to fulfil the grant of share options; and the provision of forfeitable securities.
What should be done?
Given the wide scope of the new regime and the narrowness of the specific exemptions, caution should be exercised when using EBTs and EFRBs or other third party arrangements that involve employee benefits. As no tax avoidance motive needs to be demonstrated for the legislation to apply there are potential pitfalls for the unwary.
Where existing arrangements will fall foul of the new rules it may be possible to unwind these in certain circumstances without adverse tax consequences. However, the new rules are complex (and not yet in their final form) and specific advice should be sought before taking any action.
John Forde, Assistant, Fladgate LLP (email@example.com)