Contractors' Questions: Why did IT contractors use Employee Benefit Trusts?

Contractor’s Question: Why did many contract IT workers apparently use Employee Benefit Trusts and, assuming it was for a tax advantage, how precisely did these vehicles reduce their liabilities to HM Revenue & Customs?

I’ve read that a significant number of small family companies also apparently used EBTs, at least according to some media reports of an HMRC internal estimate document on EBTs. Similarly, what did these small firms find attractive about EBTs? Lastly for my own purposes as a one-man band, and bearing in mind that the avoidance industry is often one step ahead of the taxman, are there any variants of EBTs that have popped up that are not deemed at risk of challenge from HMRC?

Expert’s Answer: The reason that a number of contractors patronised tax avoidance schemes that used EBT's was quite simple - the lure of retaining a high proportion of their income and giving less of it to the taxman. Many of the scheme promoters were based offshore as were the EBT's, e.g. Isle of Man, and were offering income retention as high as 85%. Although some schemes were variations on a theme, many would require the contractor to assign their contract to the offshore provider who, in turn, would pay the freelancer a low fixed salary with the greater remainder part of their remuneration package paid out as a loan from an offshore EBT. 

The loans would be properly reported as a benefit-in-kind but the tax paid on the beneficial loan interest by the contractor would be a drop in the ocean compared with the monies that were escaping the clutches of HMRC. 

The scheme promoter’s tax planning appeared to hinge upon the fact that the loan would not be written off nor an intention for the loan to be repaid by the contractor, thereby escaping a hefty tax charge.

HMRC does not like EBT's and the more shrewd promoters should have perhaps foreseen what was coming. The Revenue's first display of their dislike for EBT's related to their use in obtaining a corporation tax deduction. This culminated in the Dextra Accessories case (2005) that the Revenue ended up winning in the House of Lords. Two years later there followed the Sempra Metals case. 

In terms of small family companies, they have used EBTs as a tax-efficient way to provide benefit to employees and their families for the purposes of attracting and retaining quality staff. They are able to obtain a corporation tax deduction for the contributions to the EBT as and when a qualifying benefit/expense is made out of the trust. Generally this will be a payment that gives rise to an income tax and NIC charge. EBTs have also been useful by family companies in succession planning. 

Given the disguised remuneration rules that took effect from April 6^th 2011, which provide measures to ensure that tax on employment income is not avoided or deferred through the use of such vehicles as EBTs, together with HMRC's warning about EBTs in their 'Spotlights' section, I would not recommend that a one-person company contemplates their use. As I mentioned above, HMRC does not like EBTs especially when they are used in a contrived and artificial manner. Such arrangements are guaranteed to attract the Revenue's attention and challenge, in which case there will only be one loser - the poor contractor.

The expert was Andy Vessey, senior tax consultant at Qdos Consulting.