EFRBs Dealt a Crushing Blow

Employee trusts come in various shapes and sizes, and because according to HMRC they have been used for extensive tax avoidance in recent years they have been subjected to close scrutiny. This mostly dates back to the late 1990's, when Dextra Accessories Limited (which was a company in the Phones 4U Limited group) appealed against a decision of HMRC to the effect that there could be no corporation tax deduction for sums paid into an employee benefit trust until such time as those funds were released to employees as emoluments. HMRC won in the House of Lords and in the wake of that success, then repeatedly tinkered with the legislation. All the relevant changes were designed to establish beyond doubt that the principle laid down by the House of Lords was firmly rooted in the legislation. Currently, section 1290 Corporation Tax Act 2009 deals with this issue and prevents a deduction for corporation tax purposes for "employee benefit contributions" until such time as there are payment out to employees.

Commonly, payments have been made into an employee benefit trust which has then made loans to the employees or to members of their families. These loans will give rise to a benefit in kind charge on the employees, but they do not enable any corporation tax deduction to be claimed by the employer company itself. As far as we all knew, this was all as HMRC wanted it to be as the only other focus of its attention has been some suggestions that in the case of close companies there might be inheritance tax consequences where funds are transferred into an employee trust (although HMRC had lost this argument at the Special Commissioners in the case of Postlethwaite's Executors in 2007 and did not appeal).

If we had thought that HMRC were broadly content with this overall scenario, then we were mistaken. It was announced earlier this year that more changes were afoot to deal with "disguised remuneration" via employee trusts. It was also confirmed at the time that these provisions would equally apply to unapproved pension schemes (commonly known as EFRBS).

The draft legislation can only be described as draconian. One hesitates to adopt this description, since it is so often applied to new anti-avoidance legislation, but there really is no other conclusion to be reached.

It is stated to apply to any arrangements where "it is reasonable to suppose that, in essence, the relevant arrangement...is a means of providing" rewards or loans in connection with a person's employment. This nebulous wording is no doubt intended to enable the provisions to be applied as widely as possible, but clearly the main focus is employee trusts and EFRBs.

Where the trustees of any such trust earmark funds within the trust for anybody's benefit, the earmarked funds are immediately treated as having been distributed to that person and are as a result immediately taxable as his or her employment income. It does not matter that the person has no legal right to draw out the money from the trust and does not in fact take any benefit. Furthermore, there is no definition of the word "earmarked" so all sorts of situations might be said to cause liability under this heading. For example, if funds are paid into an EFRB to provide an unapproved retirement fund for a particular person, it could be easily said that these funds are earmarked for his or her benefit.

If that sounds bad, it gets worse. If the trustees make a payment of money to a beneficiary out of the scheme, no matter what the terms of the payment are, that too is immediately taxable as employment income. Payment includes any loan, even a loan at a commercial rate of interest, (an exception for commercial loans is very narrowly drawn to apply broadly to financial institutions only). It does not even matter if the loan is later repaid, as there is no provision to recover the tax charged when the loan was made. In other words, there would be no point whatsoever in making a loan as from 9 December 2011.

If the trustees acquire a property and rent it to a beneficiary of the trust, that equally counts as a taxable event and the full value of the property is liable to be taxed as employment income of that beneficiary.

As far as we can recall, there is no parallel to tax provisions of this type in living memory. The idea that the short term use of money or property gives an immediate tax charge on the full value of that property is so radical as to make one read the provisions several times over looking for balancing provisions to prevent disproportionate tax charges. There are none.

In the case of EFRBS, the rules override the existing tax charges (at s394 ITEPA2003) on payments from the fund, and in future all payments will be linked back to the relevant employment. This means that will still be a liability if the EFRB is offshore and the relevant beneficiary has since left the employment and moved abroad. Pay As You Earn will be applied, primarily by the trustees, but if they do not satisfy this obligation, HMRC can then recover the PAYE liability from the company itself. This will no doubt introduce considerable difficulty where there may be a sale of a company in the future which has already established an EFRB.

The provisions take full effect on 6 April 2011, but there are anti-forestalling rules which introduce similar provisions as from 9 December 2010. The main difference with the anti-forestalling rules is that the tax charge under them does not arise until 6 April 2012 and if by that stage the arrangements have been unravelled it can be possible to escape liability.

EFRBS will continue to have their uses as unapproved retirement pension funds. However the tax charge on earmarking is a serious concern for them as sooner or later it could easily be said that the fund is earmarked for a retirement income for a particular person and in that event there will be an immediate total tax charge on the value of the whole fund.

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