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Last week, I took an initial look at employee benefit trusts and the latest version of these, the family benefit trust.

There’s a fairly long history of legislation and litigation on the subject which, after the 1989 Finance Act, the Dextra case and 2003 Finance Act, leaves us in the tolerably clear position whereby contributions to EBTs made by companies would not be deductible until the payments from the trust were assessable by the receiving employee or director.

The HMRC seems relatively comfortable with this situation. As things stand, it would also seem that a loan to an employee or director would not incur a tax charge of itself, except to the extent that interest is paid at a rate less than the official rate. Any outstanding debt on the death of the borrower would form a debt on his or her estate for IHT purposes.

The latest case on this fascinating subject is that of Sempra Metals.

The employer in this case had initially operated an EBT and subsequently a family benefit trust. I will look first at the employee benefit trust.

Sempra, the employer, established a (Dextra-like) EBT in 1995 to provide benefits to past, present and future employees and their families.

Employees could decide whether to take a cash bonus or a payment into the trust. If choosing the latter, funds would be earmarked for their benefit and the employee could request a loan, usually interest-bearing (albeit at a low rate), and repayable on demand.

If an employee left the firm there would be no arbitrary calling in of the loan, and, on the death of an employee, the loan could be renewed in the name of the deceased’s spouse or children.

Sempra argued that the payments to the EBT should be deductible as they were incurred wholly and exclusively for the purpose of the trade. It added that payments should be recorded as an expense in the profit and loss account in the year to which they related. This was based on the fact that, when paid into the EBT, the contributions were immediately allocated to employees and there was an expectation and constructive obligation to those in the bonus scheme to make a payment.

Finally, Sempra noted that as the loans made to employees were true loans, they were neither emoluments nor earnings and so no assessment to income tax or NIC should be made.

Broadly speaking, HMRC argued the opposite.

If Sempra were correct in respect of the EBT, there would have been deductibility but no assessability. If HMRC were correct, there would be no deductibility and assessability.

It was decided by the Special Commissioners that payments to the EBT were made wholly and exclusively for the purpose of Sempra’s trade. But while the payments were deductible for accounting purposes they were not for tax purposes due to the 1989 and 2003 legislation denying deductibility if there is no assessability.

The payments did not constitute emoluments and nor did the loans, so there was no liability to deduct PAYE or NIC.

Of course, although there was a liability to tax on the benefit of the loan year on year, this position still left the beneficiary in an advantageous position with regard to accessing the cash made available by the employer.

Very simply put, if the employer had paid a cash bonus of £100,000, the amount received by the employee would have been diminished by tax and NIC so that, assuming the recipient was a higher-rate taxpayer and had earnings over the NI threshold, £59,000 will have been received.

The cost to the employer would have been increased by tax-deductible employer’s NIC (£12,800) but reduced by the corporation tax saving on the deductible bonus.

The net cost to an employer who is a 28 per cent taxpaying company of the gross £112,800 expenditure would be £81,216. There would also be some professional fees involved.

By using the EBT, the employer would receive no corporation tax deduction but the employee/director would, typically, receive access to the full amount paid in by way of interest-free loan.

If the employer wanted merely to keep the net expenditure the same at the point of payment then a payment of about £80,000 could be made into the EBT.

There would be no deduction for the employer but also no assessability on the employee. The employee would then be granted an interest-free loan of £80,000.

So, for no extra cost to the employer, the employee would have access to an additional £21,000. The employee would then have a tax liability each year on the benefit of the loan.

For example, if the official rate of interest were 5 per cent and the loan were interest-free, there would be a benefit of £4,000 each year. The tax cost at 40 per cent would be £1,600.

I will look at the FBT part of the decision next week.I am drawing down income from my pension fund and I am seeing its value fall dramatically due to the current conditions. Can you tell me how this all might affect my income today and in the future?

You are right to be concerned about your future income and the value of your fund. If you maintain your current income level with a falling fund value, it will become more difficult for the fund value ever to re-establish itself in the future.

We must not forget that a 20 per cent fall in value needs a 25 per cent increase to return to its original value. If, during that period, you are withdrawing, say, 6 per cent of your fund, then, as the value of the fund falls by 20 per cent, the 6 per cent represents 7.5 per cent of the lower fund value.

For income drawdown before age 75, more correctly called unsecured pension, the default situation is that a review has to take place at least every five years. When a review takes place, a factor is produced at that time based on Government tables, economic conditions and your age.

This factor is then applied to the value of your fund at that time to produce a maximum level of income that can be paid until your pension is next reviewed.

You are at liberty at any time to draw down an amount varying between nothing to the maximum figure in each 12-month period from the review date. Any amounts unused in a 12-month period cannot be used subsequently.

Naturally, a falling fund will mean that at any review time, the amount of income available would reduce.

Economic conditions can conspire for the factor to move up or down and, under normal conditions, you should expect the factor to move up or down in line with annuity rates.

The end result is that, at present, with falling values, if a revaluation took place, you can expect the maximum income available to you to fall. In times of plenty, you could ask for a review to take place at the next anniversary and, on the basis the conditions work in your favour and your fund has increased, then you can anticipate your maximum income for the following five years to be increased.

Other events can trigger a review. You, as the member of the scheme, can ask for a review at each review anni-versary date. If you do so, you are then bound by the new limit and you then put in place a new five-year period.

If, following divorce, a pension-sharing order is placed against your pension scheme in drawdown, then, from the beginning of the next scheme year, a new drawdown limit will apply to the pension that remains with you. Crystallising additional benefits in the form of more drawdown or purchasing an annuity also triggers a review.

As you move through age 75, the rules change again. Unsecured pension ceases at 75 with the income drawdown being replaced by what is known as alternatively secured pension.

The rules concerning Asp differ greatly. The maximum annual income entitlement in Asp will be calculated by applying a new income factor at your 75th birthday. The factor at this date will produce a maximum income roughly 25 per cent less than that applicable the year before. The Government has some strange reason to believe this would prevent you from exhausting your pension fund.

The minimum income also increases from nothing to a little over half the maximum amount. From then on, the maximum annual income is reviewed on an annual basis relative to the fund value each year.

Unlike unsecured pension, where the factor will increase with age, in Asp the factor is based on the calculation at age 75, irrespective of your actual age. All this complication conspires to restrict the maximum income available to you after 75.

It is important to review your situation continually while drawing down income from a pension fund. Drawing down income is always a high-risk strategy with the alternative being security and guarantees offered by purchasing an annuity.

Do not forget that at any time, whether in unsecured pension or alternative secured pension, you have the ability to use some or all of your pension fund to purchase an annuity. We currently have the strange anomaly that, with all the bad economic conditions, non-escalating annuities are at a high level that has not been seen for many years.

Richard Jacobs is managing director of Richard Jacobs Pensions & Trustee Services


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Neil Jones is technical support manager with Canada Life’s ican Technical Services Team. Canada Life offers a range of wealth management solutions, including retirement income planning, estate planning and investment solutions from a choice of jurisdictions, including the UK, Isle of Man and Republic of Ireland. The residential nil-rate band (RNRB) was first announced in […]


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