Caught in the net?

  • Author : Fiona Corbet
  • Date : April 2011
ABOUT THE AUTHOR: Fiona Corbet TEP is Manager at Mercator Trust Company Limited

On 9 December 2010 the UK government published draft legislation for the Finance Bill 2011 and announced that there would be a two-month consultation period. Part of the draft legislation is focused on disguised remuneration, which is the relevant section for this article. At the time of writing we are at the end of the second month of consultation and, given that this article is short in comparison to what needs to be considered, what follows is something of a whistle-stop tour.

What is clear is that the legislation, as drafted, is intended to capture what is thought by HM Revenue and Customs (HMRC) to be disguised remuneration in corporate schemes, such as EBTs (Employee Benefit Trusts) and EFRBS (Employer Funded Retirement Benefit Schemes), as opposed to the personal pension schemes used by individuals, although care should be taken if the contributions originate from the individual’s employer. The consultation period is intended to be used as a time to iron-out the legislation with HMRC to avoid capturing as many innocent schemes as possible. It is likely that, even at the end of the process, some innocent schemes will be captured, but we live in hope that HMRC will be open to negotiation on a case-by-case basis.

As it stands, most personal QROPS (Qualifying Recognised Overseas Pension Schemes) and QNUPS (Qualifying Non-UK Pension Schemes) appear to have escaped the net, provided they are set up as non-employment related. It remains to be seen as to whether any revisions to the legislation by HMRC change this. The pension schemes that we know will be captured to some extent are those that are employer-funded, which include EFRBS and, as mentioned above, corporate QROPS and QNUPS.

Who is caught?

So, how do the schemes fall into the net? There are three relevant events, any one of which can bring a scheme under the new legislation. The first event is: has the corporate scheme earmarked any funds for any one individual, be it a former, current or future employee, after 6 April 2011? Bear in mind that earmarking can be informal – if a sum of money or a specific asset within an EFRBS pot is, however loosely, known to be for the benefit of a specific individual or connected person (widely defined), it is considered earmarked. If the answer is yes, then this is likely to be a trigger event.

The second event is the actual transfer of the funds/asset. Many transactions are captured, including loans to individuals or connected persons; use of assets such as furniture or art, etc.; and use of property or land and even leases if part of the value of the whole property can be attached to the freehold, although it is hoped there are arguments against this. The draft legislation even captures those loans to individuals who have to initially pay tax in more than one jurisdiction while they await their double tax treaty refunds and those individuals in share option schemes that require loans in order to take up a share offer. These are obviously short-term loans and not any form of disguised remuneration and so hopefully these scenarios will be on the list to be ironed-out.

There is a short-term exception, which is for loans made between 9 December 2010 and 6 April 2011 that are chargeable; however, if they are repaid in part or full before 6 April 2012 there is relief that can reduce or eliminate the tax liability, depending on the amount repaid. This also appears to apply to a loan made by a bank to an individual where the relevant scheme has provided security for the loan.

It would also appear that an extension to an existing loan, if there is no further advance, should fall outside the new legislation.

The third event is the use of a specific asset by an individual or connected person. This is the one that may catch people out. For example, if a chattel is in an employee’s house and could be ‘enjoyed’ by the person living there, it is considered as being made available. The fact that the individual has no legal right to that asset or that they do not actually benefit from it is disregarded. The charge is based on the value of the asset or the price paid for it by the scheme, whichever is the higher. There is, however, a requirement under the legislation that would appear to indicate that a person who benefits from an asset being made available to them must benefit in a way that is substantially similar to the way an absolute owner would benefit. It may be that this was added to try and separate out those assets that were not destined to be returned, but to be enjoyed during the individual’s lifetime.

How much?

So, now you know you are going to be charged, how do you know what you are going to be charged? First, you must determine the value of the triggering event and that the value counts as employment income. Where it is a loan, the value is easily determined; however, where there is an asset you must know the value of that asset at the time the step was taken. There is some argument over the value of leases and whether they have their own value or whether part of the freehold value is attached. This may depend on whether the scheme owns the freehold or whether it only owned the leasehold anyway. If the freehold was purchased and there was no lease in existence, it is probable that there could be an argument that a new lease had no value. If market value rent is paid and the scheme still holds the freehold, then it could be viewed that the freehold retains its value, so no part of that value can be apportioned to the lease.

It may be possible to structure the scheme so that no specific funds are tied to one individual

It is also necessary to consider whether there is any retroactive effect if investments made before 9 December 2010 are switched at the behest of an employee or any hedging arrangements are to be made by an employer. By making the request, that investment will almost certainly be classed as earmarked to that employee.

It appears that the draft legislation may treat pension payments from an employer-funded overseas scheme as employment income for a resident non-domiciliary recipient in receipt of a foreign pension even though it is pension income. This would appear to exempt them from claiming the remittance basis.

You also need to ask yourself, were the funds in your EFRBS or EBT earmarked before 9 December 2010 or did the earmarking occur under the new legislation? If there are conditions surrounding the receipt of the funds, the way the legislation is drafted means that if these funds are for specific employees, there is a charge on allocation, not on receipt. If the conditions are not met and no funds are received, the draft legislation does not appear to contain a provision for repayments. It may be possible for the employer to structure the scheme so that no specific funds are tied to one individual and so that no one individual is allocated anything more than a potential expectation of some amount to be determined at a future date from a communal pot.

If the funds were allocated pre-9 December 2010, they do not fall under the legislation immediately. However, the first transaction after that date taken at the behest of the individual will potentially bring those funds under the new legislation. If the transaction is a payment, it is possible to repay the amount by 6 April 2012 and mitigate all or some of the liability; however, those funds would then be considered as earmarked for that individual.

Wait and see

So, where do we stand? It is something of a ‘wait and see’ game until the legislation is final and the consultation has been completed. It is hoped that HMRC will consider circumstances carefully and, for those of innocent schemes and where payments are clearly not remuneration, revise the legislation accordingly. Professional advice from your tax advisor should be sought if there is any doubt whatsoever that a proposed transaction may fall under the new legislation – which will be most of them – in whatever form it finally rests.


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