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Sempra’s new clothes

My last couple of articles have looked at recent developments in HM Revenue & Customs’ attitude towards employee benefit trusts.

Last week, I considered a case involving a business, Sempra Metals, that was heard before the special commissioners. Sempra had been contributing to an EBT for some years but in 2002 it ceased the payments and replaced the EBT with a family benefit trust. This was very similar except that only members of employees’ families and not employees themselves could benefit.

The aim was to secure deductibility, the payments being made wholly and exclusively for the purpose of the trade, but for the payments not to be assessable as they were not emoluments, not being made for the benefit of employees of Sempra.

It was also hoped that the loans made to the FBT beneficiaries would not be treated as emoluments and that the expectation of loans would not characterise the payments into the FBT as emoluments.

The issues at hand in connection with the FBT all stood to be decided on the basis of the law as it stood after the 2003 anti-avoidance legislation was put in place. Under the 2003 provisions (Sch 24 para 9) an “employee benefits scheme” was defined as “a trust, scheme or other arrangement for the benefit of persons who are or include (present or former) employees of the employer”.

Sempra argued that although payments were clearly made by the employer to the trust, as the trust excluded employees of the company from benefiting, even though their family could, it was not an employee benefits scheme. In support of this, it was argued that “benefit” must be taken to mean a legally enforceable arrangement.

However, the special commissioners decided that the FBT was “beneficial” for the employees as their families could benefit and that the meaning of “benefit” extended to arrangements that were “beneficial”.

Payments to the FBT and loans to employees’ families benefited the employees both directly and indirectly. Apparently, in some cases, loans were made to joint accounts held by family members and employees, such as married couples where one was an employee.

The upshot, pending any appeal, is that payments to an FBT will not be deductible for tax, even though they will be for accounting purposes, but will also not be assessable. The making of a loan to a family member will also not give rise to an assessment as the payments to the trust did not vest unconditionally in the employees. The family members can benefit through applications for loans but the final decision remains with the trustees.

Where does this leave us? Once again, pending the outcome of any appeal, it seems that FBTs are a means of allocating funds to a trust for the benefit of the families of employees and providing them with access to funds via loans that while not being deductible for corporation tax, will not be subject to PAYE and National Insurance.

Given that the exclusion of employees from all benefit in the Sempra case did not achieve its purpose, there seems to be no need to incorporate such an exclusion in FBTs to secure the non-deductible/ non-assessable result. However, inclusion of the family of employees within the class of beneficiaries appears to be important to avoid the trust fund being treated as if it is the employee’s own.

Loans from FBTs are typically made interest-free or at low interest rates. The yearly employee tax charge, even if loans are made to family members, is on the benefit of the loan, that is, the amount by which interest actually charged is less than the official rate. To the extent that interest is paid, it is added to the employee’s sub-trust under the FBT and can be used to pay future benefits to the employee or their family.

Greatest tax efficiency can be achieved if non-cash benefits, including loans, are made after employment has ceased when under current law it would seem that they can normally be made tax-free. Also, to the extent that a loan is outstanding on the borrower’s death, the value of that person’s estate will be reduced for inheritance tax purposes.

It is thought there could be some risk in connection with trusts set up for members who are also substantial shareholders. The risk is that the corporation tax deduction could be denied due to a duality of purpose and that, in the case of close companies, the shareholders could be treated as making a gift for IHT purposes.

As it now seems tolerably clear that there is unlikely to be a deduction for the company if there is no corresponding assessability of the employee, then the FBT route may not be appealing for quoted companies, even though it is for the “benefiting” employee. This will be less of an issue for private owner-managed companies.

It also has to be kept in mind that if a taxable benefit is paid from the trust, for example, a payment out of trust not by way of loan, it is the employer who has to bear employers’ NICs. This means the employer may have a future latent liability over which it has no control. Of course, this risk could effectively be diminished if the employer is also a trustee. Such latent potential liability may deter a potential purchaser of the company.

Finally, it is clear that HMRC will do all it can to enforce the outcomes it expects. If it is unsuccessful in the courts, then legislation is not unexpected. As these arrangements are clearly seen as avoidance vehicles , one could also not rule out retrospection. Advisers must be fully aware of this before recommending such an arrangement to their clients.

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