Employee benefit trusts are more commonly being offered to employers purporting to provide:
– tax deductibility for contributions made by the employer
– non assessment of contributions on the beneficiaries
– freedom from National Insurance Contributions (for employer and employees)
– inheritance tax freedom
– the capability to remove sums substantially if not entirely tax free (or at least tax deferred) for the benefit of employees.
These comments are based on a variety of schemes we have considered. We have no information to suggest that the EBT (or a particular type of EBT) is currently being challenged by the Inland Revenue. However, comprehensive research has not been carried out. It must be appreciated though that EBTs represent fairly aggressive tax planning – especially when the EBT is sited offshore. It is thus, we believe, essential to check/enquire into the following:-
1. If the EBT arrangement provides relevant benefits it could be categorised as a funded unapproved retirement benefits scheme (FURBS) meaning that contributions made to the scheme would be subject to income tax and National Insurance on the member. The concern is that even though the trust deed might prohibit the trustees from paying any benefit that was a "relevant benefit", if a relevant benefit was clearly within the contemplation of the plan the trustees may in fact pay such a benefit despite being in breach so that mere words of prohibition (on payment of relevant benefits) will not help.
It is therefore important to examine precisely what a relevant benefit is. Relevant benefits are defined in section 612 ICTA 1988. They include a pension, lump sum, gratuity or other similar benefit which is, or will be given
– when a person retires or dies
– in anticipation of retirement
– after a person has retired or died (if the reason for payment is in recognition of past service) or
– as compensation for any change in the conditions of a continuing employment.
However, the Inland Revenue have stated that disability benefits (whether regular payments or lump sums) are not relevant benefits if they are payable solely because of an employee's death or disablement by accident while employed.
If the trust deed specifically defines death benefits as any pension, lump sum or other like benefit to be provided to a beneficiary (employee) in the sole event of the accidental death of a beneficiary whilst in the service of the employer (or words to that effect), it would seem that such death benefits will not be regarded as relevant benefits. So a tax charge should not arise on employer contributions to the scheme purely because of this.
However, there may be a practical point here to be addressed. Namely, what happens if a beneficiary dies other than from an accident? Any lump sum payment that is then made to the dependants of that beneficiary could then be a relevant benefit. Of course, if there is an exclusion of payment of relevant benefits, even if the trustees wished to make such a payment they may be prohibited from doing so. Clearly this aspect, if relevant, needs further thought as if this is the case then the family/dependants of the deceased beneficiary may not benefit in those circumstances so that by satisfying the “non relevant benefit” condition, dependants may be denied benefit. It may however be accepted that this is a reasonable price to pay for the desired tax benefits.
2. It is understood that, under many offshore arrangements, the trustees make a payment to an investment company who make the investment of the contributed funds. If income arises on such investments, either directly or indirectly, because the trustees have wide investment powers it will be necessary to consider sections 739 and 740 ICTA 1988 – the transfer of assets abroad legislation. Please bear in mind that the associated operations provisions could well be in point here as the ultimate transferor may be the UK company sponsoring the EBT.
For section 739 to apply there must be an individual transferor. A company is not an individual but, where the company is say a close company, the Inland Revenue could attribute the transfer to individual shareholders (IRC -v- Pratt). Whether they would choose to do so would depend on the facts of the case. Clearly, if the contribution was paid to a trust under which a number of employees would benefit (not just proprietors) this would help in resisting a section 739 problem.
Section 740 could apply when a payment is made out of the trust (via the investment company) to a UK ordinarily resident beneficiary. In this respect a "benefit" can be charged to income tax to the extent that income has arisen on the transfer overseas. Four points arise here:-
(a) The fact that the initial transfer is to the trust and not the investment company will not necessarily avoid the problem because the payment from the trustee to the investment company, be it an interest-free loan or otherwise, is undoubtedly an associated operation.
(b) If investments are loosely (or specifically) earmarked for a particular individual it would be fairly straightforward for the Inland Revenue to allocate income to or for the benefit of a particular individual particularly if that individual were a shareholding director or a relative of a shareholding director. It is essential to take fully into account the importance, in this context, of the trust being substantially and not just formally discretionary.
(c) If any loan to the executive bears interest at current market rates, it may well be that this does not represent a "benefit" and so no section 740 (or indeed Schedule E liability) would arise.
(d) Investments could be made in non-income producing assets to avoid this problem – for example zero coupon preference shares. Investments in pooled non-income producing investment funds such as offshore investment bonds should also avoid income (or capital gains for that investor) arising (but see 8. below).
It may well be unwise to rely on the "let-out" in section 741 ICTA 1988.
3. The avoidance of the capital gains tax settlement provisions often (even usually) relies on the arrangement falling within the ambit of the Inland Revenue statement that the establishment of and payment into the EBT is a commercial and bona fide transaction and therefore not a settlement. Reliance is placed here on the correspondence on section 97(7) TCGA 1992 that “settlement” should be interpreted as for income tax. To our knowledge this statement has been issued by the Inland Revenue in relation to offshore pension schemes but not general employee trusts.
There is always a possibility that the Inland Revenue might take the view that a particular arrangement is not commercial or bona fide although to our knowledge no further detail has been give by the Inland Revenue on what they regard as commercial or bona fide. However, if the main purpose of the arrangement is to benefit proprietorial beneficiaries as opposed to non-shareholding employees (especially if this is supported by actual benefit payments) then this could give rise to difficulties. Being substantially a discretionary trust (rather than in form only) is, it is thought, essential to the tax success of the EBT.
4. If the arrangement falls within the definition of a "sponsored superannuation scheme" in section 624 ICTA 1988 (as most would) inheritance tax should not arise on lump sum death benefits payable (but see point 1. above as to whether such a lump sum payment can be made).
5. Considerable thought has been given to the question of deductibility of the company contributions notwithstanding the lack of complete assessment on the employee. Whether or not the trustees can be viewed as "mere intermediaries of the employer" may well be critically important and is clearly a highly subjective issue. The fact that the EBT trustees will usually be intermediaries of the employer within section 203B(4)(b) ICTA 1988 may also be relevant. The following points should be borne in mind:-
– Contributions made by the employer to the EBT do not automatically qualify for tax deduction. The payments to the trust must satisfy the requirements of section 74 ICTA 1988 in the same way as any other form of expenditure. Contributions to the trust are only deductible if they are:
(a) revenue rather than capital in nature
(b) paid wholly and exclusively for the purposes of the company's trade (see the recent case of Mawsley Machinery Ltd -v- Robinson)
(c) not contributions to an unapproved retirement benefits scheme
If the trust assets feature on the balance sheet in accordance with Urgent Issues Task Force 13 (UITF 13), there is not necessarily a deduction at the contribution date. This is a very important point and one that has been discussed extensively in connection with ESOP trusts. There appears to be some division of opinion over whether its terms apply in respect of non-ESOP trusts.
– Section 203(B) ICTA 1988 will treat the trustees as an intermediary of the employer and imposes the responsibility for the operation of PAYE on any cash payments or readily convertible assets, even though the trustees may be outside the UK.
– The Contributions Agency may argue that the secondary contributor in relation to the payment of remuneration to a person employed under a contract of service is the employer rather than the person making the payment (trustee). Accordingly, it is doubtful that cash or other benefits subject to NIC will achieve any NIC savings in respect of discretionary payments.
– Payments made after an employee has retired may not necessarily escape a tax charge.
– The requirements of section 15(5) of TMA 1970 require the employer to provide details of all benefits which have been “arranged” by him.
This whole issue of deductibility appears to have already received considerable attention. Provided the above points are borne in mind there is little more that we can add. Responsibility for this issue (as with all other tax issues) rests with the employer's legal advisers.
6. Some thought also needs to be given to the precise way in which each arrangement will operate. For example if, say on the retirement of a beneficiary, a loan is made to him and that loan is spent by the beneficiary, presumably the investment company would then request repayment of the loan on his subsequent death. In such a case the beneficiary's dependants would need funds to repay the loan unless there was some form of appointment of benefit by the trustees to neutralise the outstanding loan. What is the position here? Is there a condition that the loan must be repaid? What happens if the beneficiary has spent the loan and can't repay it?
It would seem that the loan could be a debt on the beneficiary's estate provided he/she had not contributed to the trust (section 103 Finance Act 1986) although an appointment of benefits by the trustees in favour of the beneficiary may neutralise this. What would be the income tax position on any such appointment of benefit? It is thought that it may be hard to resist an assessment.
7. Does the arrangement contradict company law by indirectly providing a beneficiary who is a director with a loan from a company – especially if it is the trustees who are regarded as making the loan? Clearly this would seem to be an "arrangement" within the meaning of section 330(7) Companies Act 1985. One should always enquire whether Counsel addressed this issue. This is of course a legal point and not a tax point and it is worth noting that in the analogous position of pension mortgage plans for directors of companies a relaxed (and pragmatic) view has been taken in the past.
8. If the trustees consider investing the assets of the offshore EBT into offshore investment bonds then, whilst this will usually be entirely possible and would mean that no income would be generated in the trust, it should be borne in mind that any chargeable event gains arising on encashment of the policy would be assessed on the employer company who created the trust (section 547(1)(c) ICTA 1988). However, the company could recover any corporation tax liability from the trustees.
9. If the trustees consider investing in a commercial property from which the employer company could operate there would seem to be no problem with this provided the arrangement was on commercial terms e.g. full market rent was paid.
10. These types of EBT arrangements have now been available for some years and to our knowledge we do not know of a case where the Inland Revenue have challenged them. There was however the Mawsley case (see above) on deductibility. EBTs do represent aggressive tax planning that, for much of the benefits, relies on the arrangement being construed as both genuine and commercial. Clearly, given the tax advantages on offer, a future change in the Inland Revenue's attitude cannot be ruled out and this must be borne in mind. For this reason the comments made above should in no way be taken as an endorsement of any scheme. Potential users must always take their own professional advice in deciding whether to establish such arrangements. These general comments are thus provided on this clear understanding. Consequently, no responsibility can be assumed for any loss arising in any way.