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EBTs - A guide and history for IT contractors
HMRC have been busy sending letters to EBT scheme users. If you have had an enquiry from HRMC please read the item Contractors' Questions: How to handle HMRC enquiry on loans from EBTs? or ask for advice on the forum http://forums.contractoruk.com/accounting-legal/86442-hmrc-enquiries-loans-ebts.html
Are Employee Benefit Trusts really dead?
Companies using employee benefit trusts (EBTs) and potential beneficiaries of such trusts should seek specialist tax advice as soon as possible as HM Revenue & Customs clamps down on loopholes, writes Gerry Brown, manager of Tax and Trusts at Prudential.
The attack on EBTs, announced in December 2010 and confirmed in the Finance Bill on 31 March 2011, means that employees, beneficiaries or trustees of EBTs need to evaluate the continuing usefulness of these structures. Additionally those in dispute with HMRC over the tax consequences of setting up and or using EBTs should consider some compromise with HMRC to bring the tax affairs of those involved fully up to date.
What is an EBT?
EBTs, which have been around since the late 1980s, have been used extensively by high-earning employees – ranging from IT specialists to Premier League footballers.
They are used to minimise the income tax and national insurance charge on remuneration to employees and directors and also generate a claim for corporation tax deductions for payments into the trust.
An EBT is simply a discretionary trust – with “offshore” trustees - designed to act as a “money box” for those high earning employees who do not need immediate access to their full remuneration package. In other words, those who are prepared to defer access to remuneration in the form of bonuses and perhaps share options.
The employer establishes the trust making contributions of an equivalent value to the deferred remuneration and the trustees will – at a later date – distribute the trust funds to employees or ex-employees. The basic idea is that the trustees can distribute the trust fund when it is tax advantageous to do so – perhaps when the employee is retired or non-UK resident.
The ideal is that there is no employee tax charge until the trustees distribute benefits – which may be many years after those benefits have been earned. The tax charge may be theoretical rather than real – the employee or ex-employee may have moved to a ‘low tax jurisdiction’ or ‘tax haven.’
EBTs have many of the characteristics of a pension - without the restrictions that UK pension legislation applies to contribution limits and the nature and timing of benefits.
Were there any downsides to EBTs?
EBTs can be complex and expensive to set up and administer. Employees are only potential beneficiaries – they have to rely on offshore trustees exercising a discretion in their favour. There is also no certainty of benefit. HM Revenue & Customs (HMRC) has been consistently “opposed” to EBTs since their introduction in the late 1980s and anyone using an EBT is likely to come under HMRC scrutiny.
What has the government said?
The government’s attitude is that the tax advantages offered by EBTs are too generous.
The tax rules applicable to their use have gradually been tightened. Finance Bill 2011 contains provisions intended to finally kill them off as tax planning arrangements.
The Finance Bill provisions will impact “new” EBTs. Existing EBTs will also be affected but may well retain a degree of effectiveness.
HMRC is still ‘fighting the good fight’ against existing EBTs.
There are three areas of dispute:
1) Can the employing company get a corporation tax deduction for contributions to the trust (as it would for payment of “immediate” salaries and pension contributions)?
2) At what point do employees become subject to tax (and NIC where relevant) on benefits provided by the trustees?
3) How are the employing company contributions to be treated for inheritance tax purposes?
HM Revenue & Customs is offering employers – and employees - who have used EBTs and “similar arrangements,” the opportunity to resolve any outstanding tax liabilities without recourse to litigation.
Employers, trustees or beneficiaries willing to reach a final settlement with HMRC will have to pay any unpaid tax charges as well as interest on the sum.
This is problematical, because the precise tax treatment of EBTs has not always been clear in spite of HMRC now offering to sweep up all tax issues in one go.
Sponsoring companies and beneficiaries should seek specialist tax advice as soon as possible because it could be that a company underpaid corporation tax, or an employee received a benefit that triggered a tax charge but did not report it. What HMRC would like to do is take an EBT, look at the various tax aspects and determine where there is a liability – in respect of the employing company, current and former employees. The HMRC ambition is to reach a settlement with all parties without having to resort to expensive litigation
Litigation is expensive and HMRC has relatively deep pockets. HMRC has enjoyed considerable success when it takes disputes to the Tax Tribunal and/or Courts for determination. Of course HMRC only takes cases where it is confident of a win!
HMRC has reported reached settlements with several large banks that used EBTs to remunerate senior employees. A scheme operated by a leading investment company – Aberdeen Asset Management – was HMRC’s most recent success before a Tax Tribunal
What to do now?
EBTs come in many guises and with many different names. If you are potentially affected by the changes and/or HMRC action seek specialist advice. In the first instance this advice should come through the sponsoring company or the trustees.
On a positive note EBTs designed to provide share options are often “approved” and such arrangements are not in the HMRC/Government ‘cross-hairs.’ But again, those potentially affected should consult sponsoring employers.