EFURBS
Efurbs are currently being marketed quite aggressively as a tax-efficient way
of extracting profits from family companies. The acronym stands for Employer
Financed Unapproved Retirement Benefit Scheme. Parmentier Arthur does
not market these schemes, but the comments here are offered as impartial
view on the advantages and disadvantages of these arrangements.
Efurbs are basically family trusts which can be set up by any company with
distributable profits which the directors or shareholders wish to extract as tax
efficiently as possible. The basic strategy under the marketed schemes is that
the company transfers its profits into the trust and the trust then lends them
out to either the directors or other family members who will have to pay
interest to the trust. Loans to directors or employees can be interest free once
the individual concerned reaches normal retirement age, but there will still be
a tax charge based on the benefit in kind of an interest-free loan.
The company gets no deduction against its profits until the benefits emerge
from the trust in taxable form (although some argue that the relevant
legislation inadvertently fails to achieve this with Efurbs and there is
immediate tax relief. Under the marketed schemes, the main idea is that any
taxable benefits are indefinitely postponed, so that it is accepted that there will
not in practice be any deduction for corporation tax purposes. Even so, the
profits are effectively extracted at a tax cost of the company's marginal rate of
corporation tax, normally either 21 or 28 per cent, plus the tax due on the loan
interest or loan benefit. That should be considerably more tax efficient than
taking out either salary or dividends. Equally, if one were to take a loan direct
from the close company, this would requires the company to deposit tax on
the loan at an amount of 25 per cent of the loan until such time as the loan is
repaid. So far, so good therefore, and it is clear that the schemes can produce
significant immediate tax savings.
It is generally suggested that the trusts should be operated indefinitely on the
basis of loans to family members in order to preserve the tax efficiency. This
is a perfectly acceptable way forward, although it needs to be borne in mind
that in practice the time may well come when the funds will need to be taken
out of the trust. For example, in a divorce situation it is hardly likely that the
claimant spouse would be happy to accept a settlement in the form of a loan
from the trust. He or she will require an outright cash payment. Equally, on the
death of a borrower from the trust there may not be sufficient funds in the
estate to repay the loan, if the borrowed funds have been unwisely invested,
or simply spent on holidays or other living expenses. In that event, either the
beneficiaries of the estate must take over responsibility for the loan, or
alternatively the trustees may agree to write it off. If it is written off there will
be no deduction for inheritance tax purposes in respect of the debt.
Any distributions from the trust, or loans written off, are likely to be taxable in
full at the top rate of income tax. At the same time, this will produce a
matching deduction for the company in its corporation tax computation. Of
course, by that time the company may have been wound up or sold, in which
event the corporation tax deduction will be of no interest to the family
members. The income tax charge on distributions and loans written off is
nebulously worded and the boundaries of exactly when liability arises and
when it does not are ill defined. Certainly distributions to employees or past
employees can be expected to give rise to full income tax liability; note in
particular that the liability is not on amounts up to the total of contributions into
the trust, but income tax liability on the full sum. Some of the distribution may
represent income or gains which has already been taxed in the trust, and in
that event there is double tax liability. There is a concession which may offer
some relief in relation to income tax, but all Inland Revenue concessions are
being progressively withdrawn, with some of them recast into a roughly
equivalent statutory relief.
It will be seen that 40 per cent (or even 50 per cent in the future) tax liability
on the distributions from the trust plus the corporation tax liability initially paid
in the company amounts to a much heavier tax burden than if the company
had simply paid out dividends and there had never been any trust. Payments
or benefits from the trust may also be liable to National Insurance
contributions; there is no specific legislation in the NIC provisions relating to
Efurbs, and it will be a question of whether the distributions or benefits count
as 'earnings'.
To summarise, those entering into these schemes will need to work on the
basis that the trust will need to continue for a long period of time and
extracting funds from it other than by way of loan will normally cause the tax
savings to unravel, and in some cases may cause higher overall tax liability.
On the other hand, those who are prepared to set up a structure which will
remain in place long past their deaths may expect to see long term tax
savings. We can expect the annual benefit in kind charge on loans to increase
from its current figure of 4.5 per cent in the future and even at 4.75 per cent,
the whole loan will effectively have borne an income tax charge after 21
years, with the money will still not belonging to the borrower. A tax deferred
may be a tax saved, but in this case the deferred tax does not produce the
same result as if an immediate up-front charge were accepted – the money is
still in the trust and there is no credit for on distribution for tax already paid on
benefits. On the plus side, there is the initial income tax saving to be brought
into account which might have been invested to grow to a considerable sum
over the years.
The trust itself does not benefit from any tax exemptions and will be taxed the
same as any other family trust. Some of the publicity refers to them being
'HMRC approved'; what this refers to the reporting requirements when the
trust is set up, but HMRC will do no more than accept at face value that the
trust is genuinely a retirement benefit scheme. This is different from HMRC
granting 'approval' as it does to a registered pension scheme.
One might wonder therefore what the consequences would be if the trust is
not operated as a retirement benefits scheme, for example if interest-free
loans were made to those who are not retired. The answer to this is that the
consequences could be quite dramatic. Normally on setting up a family trust
an inheritance tax liability at the rate of 20 per cent is incurred, and this
applies just as much where the funds are transferred in by a close company
(in which event the transfer is apportioned to the participators and liability
arises on them). A transfer to an Efurbs is an exempt transfer but if it comes
to the attention of HMRC that the Efurbs is not being operated as a genuine
retirement benefit scheme, they may well seek inheritance tax liability on the
participators for the funds transferred in. There is no general six-year
limitation period for past inheritance tax liability, and HMRC can seek to
enforce an inheritance tax charge for a date long before six years previous.
HMRC state that they may also seek to treat the trust as a settlor-interested
trust, with income tax liability on the company directors, this presumably being
based on the notion that they allowed their earnings to be diverted into the
trust of which they are indirectly the settlors. The trust might also be caught by
the inheritance tax gift with reservation provisions, although there are
arguments against this treatment.
All in all, the initial tax savings from these schemes can unravel in later years,
sometimes causing even greater liability. Distributions to family members after
the death of a director/employee have the best hope for escaping full income
tax liability, but that circumstance may not be available until far into the future.
Accordingly, those considering the schemes should look at what the long term
strategy with the trust is going to be, and should consider whether or not there
will an overall saving of tax under that strategy.
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