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Extra Dextra, read all about it

I bet you couldn&#39t wait, could you? Here is this week&#39s thrilling instalment in the saga of the Dextra case on employee benefit trusts. This case serves as a reminder to all those who are active in promoting EBTs that their increasingly extensive use is generally not welcomed by the Inland Revenue. This much is well evidenced by the extent of its attack on the taxpayers in the Dextra case.

As I explained last week, a very wide range of arguments were (unsuccessfully) put forward by the Revenue.

By the way, Phil, if you&#39ve got this far without losing interest, well done. (My son, in his capacity as a graduate recruit in NU&#39s marketing function, has expressed the view that my art-icles are virtually unintelligible to any sane and rational person.)

But we digress. It would appear that the main driver behind the Revenue&#39s challenge in this case was its desire to ensure that the company secured a deduction for its contributions to an EBT only when those contributions were also assessed on the beneficiary (employee) under the trust for income tax and NI purposes.

Let&#39s look at the facts. The contributions that were the subject matter of the case were made by six group companies to an EBT. Within the trust, specific funds were allocated to six sub-trusts – one for each of three director shareholders and the wives and the mother of two of the directors. All these were potential beneficiaries under the trust.

The Revenue&#39s contention was that, as payments into the trust were potential emoluments, section 43(11) Finance Act 1989 meant that the deduction for the employer should be delayed until the amounts claimed were assessed as emoluments. It also contended that the sub-funds, even though not paid out, should be taxed as a benefit in kind under section 154 ICTA 1988 because of the allocation of the payment to the sub-fund. Finally, based on the substance over form argument seen in the Ramsay case, it was argued that the whole was an artificial tax avoidance scheme and that the trust should therefore be regarded as a sham.

Some pretty fundamental issues were being considered but it is important to appreciate the importance of the facts of the case in attempting to draw conclusions in respect of EBTs generally. That the Commissioners decided in favour of the taxpayers is nevertheless encouraging to others using or considering using EBTs.

Prior to this case, the Revenue appears to have taken the view that, to the extent that funds are accumulated in discretionary EBTs and not paid out, no deduction shall take place for the employer. The main reason for its argument appears to be that accounting statements contained in the Accounting Standards Board Urgent Issues Tax Force abstracts 13 and 32 operate so that assets held in an employee trust should be treated as belonging to the employer and contributions should therefore be capital as opposed to revenue in nature. Another reason could be that the main beneficiary(ies) (as they were in this case) are substantial shareholders. Another might be that, even if contributions are of a revenue nature, they do not satisfy the wholly and exclusively test for deductibility as a revenue expense – again possibly by reason of a beneficiary being a substantial shareholding director.

Revenue antagonism does not stop at the deductibility of payments into a trust. It is also predisposed to attempt to treat particular events, such as the allocation of sub-funds to individuals, as a distribution to appropriate individuals.

The draftsmen of EBTs also need to ensure that a trust does not amount to a funded unapproved retirement benefits scheme. It would fall within this definition if it provided any relevant benefits as defined by section 612 ICTA 1988. These would include payments made in respect of retirement or death. If a trust was categorised as a Furbs, then while the contribution by the employer would usually be deductible, its payment would also be assessable on the beneficiary(ies) under the trust.

Assuming the Furbs trap is avoided, how successful can the other arguments against the Revenue&#39s contentions be? This consideration is important given the increasing activity in promoting these schemes.

The appeals (of which there were 12) before the Special Commissioners broke down into two main categories:

•Whether payments into the trust were deductible.

•Whether allocations to sub-trusts for the employees were assessable to income tax and NI.

There were many reasons why the group wished to establish EBTs. All those stated in the case were to do with attracting and retaining staff and were important to encourage employee support for reward plans by virtue of payments being held in an environment free from company influence. It was clear from the terms of the trust that monies held by the trustees could not be repaid to the employer, benefits could not be paid to the employer and could only be used to reward employees regardless of future trading conditions. Contributions were made on a discretionary basis and differed from year to year. There was no compulsion on the employer to continue contributing. Next week I will explain how employees were chosen to benefit.

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