One of Scotland’s
top professional football clubs, Glasgow Rangers, was forced into
administration by HMRC, which is trying to recover at least GBP49
million in tax and penalties resulting from Rangers’ use of
employment benefit trusts (EBTs) to pay players. With EBTs put on
the spot, several English clubs are also in serious tax trouble.
The below is one of two features about this matter. Read the other
feature here
ABOUT THE AUTHOR: Nick Wallis is Corporate Tax
Director for Smith & Williamson in London
How did ‘disguised remuneration’ come to mean ‘employment income
paid through third parties’? What, in simple terms, has been going
on? If you are a highly paid employee, and you have bought your
yacht and skiing chalet, you will not have a current need for
money. In other words, there is no point in being paid until you
need the cash because you will only be taxed. So there is no point
in drawing taxed salary and paying tax. Moreover, the result will
be even better if the undrawn pay can be invested in the meantime.
From the employer’s point of view, once the proposed remuneration
has been expensed, its actual destination is broadly a matter of
indifference provided the PAYE and National Insurance contributions
position is indemnified.
This basic idea came from the earlier planning in this area:
that ‘tax deferred is tax saved’. However, HMRC sought to oppose
this approach on the basis that it did not achieve what it refers
to as ‘fiscal symmetry’: an employer should only get a deduction
for remuneration once it has been paid to the employee and PAYE has
been paid.
The next development of tax planning in this area was to enable
the employee to access the value set aside for them without paying
income tax. In simple terms, this was achieved by the trustees of
an employee benefit trust (EBT) lending the money, either interest
free or at interest, for an indefinite period. This completed the
perfect world for the taxpayers with a deduction for the employer
and no income tax for the employee (plus inheritance tax
advantages) and it is easy to see how third-party arrangements
became big business.
Various developments in the accounting world made this treatment
slightly more difficult to achieve in certain circumstances, in
particular the introduction of UITF 32 (accounting for EBTs and
other intermediate payments), but these issues did not slow down
the planners. Unsurprisingly, HMRC started to challenge these
arrangements more robustly and this led to two important results:
first, the seminal case of Dextra v Macdonald and
second, the new legislation in Finance Act 2003 sch24.
Dextra v Macdonald
Dextra was a classic EBT planning case. The employer
paid a large amount into an EBT, which was promptly on-lent to the
employee while the employer claimed the relevant tax deduction. The
trustees testified in court that the loan was indeed a loan, and
quite properly, it was also found that in the law hitherto, a loan
is a loan and not remuneration (although, of course, interest
forgone can be a benefit-in-kind).
When the case was first heard, HMRC lost before the Special
Commissioners and it did not pursue its case against the employee
that he had received pay instead of a loan. So this point was never
heard by the higher courts and it was presumed that HMRC did not
appeal because it thought it would lose. The upshot is that
although HMRC persisted in maintaining that loans can in effect
represent pay, the Commissioners said otherwise. Dextra
may not have the status of legal precedent on this point, but it
looms over cases involving loans and is invariably cited in
taxpayers’ favour by planners in this area.
The second leg of the case concerned the availability of a
deduction for the employer for the contribution to the trust. Since
1989, there has been legislation to prevent a deduction for
employers for emoluments (as they were called) unless, and until,
they were paid. Broadly, this included situations where payments
were made to intermediaries ‘with a view to their becoming
emoluments’ (i.e. paid as remuneration). However, there were
indications that HMRC accepted that amounts paid to a trust might
represent other benefits in due course at the discretion of the
trustees.
‘Dextra may not have legal precedent, but it looms over
cases involving loans’
In this case, the Court interpreted that crucial phrase ‘with a
view to…’ as meaning ‘there was a realistic possibility’, which
simply denotes likelihood, regardless of intention. While the case
was still proceeding, HMRC decided to act, perhaps in anticipation
of losing the case. The Finance Act 2003 sch24 (now
included in Corporation Tax Act 2009 part 20 ch1) applied
to payments into employee benefit arrangements and the Finance
Act 1989 s43 was also redesigned to cover the case where the
employer made a suitable provision without making a payment to a
third party.
Fiscal symmetry
The overt message of this legislation could not be clearer.
Fiscal symmetry was to be enforced and an employer could not have a
deduction until the employee had a taxable receipt. Planners
therefore assumed that provided the fiscal symmetry rule was
obeyed, there was no problem if loans, or similar non-taxable
benefits, were taken by beneficiaries. It was thought that the lack
of deduction was a fair swap for lack of taxability on the
employee.
The original drafting of sch24 was not watertight, resulting in
planners continuing to draw up schemes to avoid fiscal symmetry. In
subsequent Finance Acts the schedule was duly tinkered with to try
to make sure it did apply. HMRC also tightened the screw by looking
at the position of close company transfers for inheritance tax.
This was followed by a reawakening of interest in employer-funded
retirement benefit schemes being used as top-up pension
arrangements following the changes to pensions tax relief, notably
in the Finance Act 2009.
‘HMRC seems to think that even if trustees simply
earmark funds it is as good as pay’
There were numerous other ideas doing the rounds. These included
inventing employments with EBTs attached, using the employer
company as trustee, getting banks to create off-the-shelf trusts so
the company could purchase a trust interest, thus bypassing the
specific rules about contributions to an EBT, and so on.
HMRC persevered. In addition to introducing counteracting
legislation, it issued a series of other publications, including
Spotlights 5 and 6 and ‘briefings’, which set out the pitfalls in
this planning. It seems these were designed, in part, to discourage
these planners. They also indicated just how far apart the views of
mainstream practitioners and HMRC were, particularly over what
constituted receipt for remuneration purposes. HMRC seemed to think
that even if the trustees simply earmarked the funds it was
equivalent to a payment and a loan was as good as pay.
There appeared to be no end to this toing and froing and,
indeed, this will continue for some time because arrangements put
in place before the disguised remuneration legislation will need to
be settled one way or another.
New regime
Although fair warning of the December 2010 legislation was
given, certain provisions took immediate effect, while others were
delayed until April 2011.
The legislation is designed to catch various mischiefs where it
is ‘reasonable to suppose that in essence’ what is going on is the
provision of recognition or reward or loans. This use of woolly
phraseology is arguably deliberate.
Have we given up on clear and concise drafting of legislation?
Perhaps so. It is almost as if the legislation is saying ‘we know
what we don’t like; we can’t describe it, but we’ll know it when we
see it, so don’t do it’. In December 2004, the then Paymaster
General, Dawn Primarolo, said ‘employees should pay the right
amount of tax’, but as we will see the new rules could mean
employees paying tax on a nil benefit: hardly ‘the right’
amount.
The catch-all nature of the legislation means detailed
exceptions are needed to permit various activities usually operated
via third parties, such as ordinary share plans for employees,
ordinary employee benefit packages like bus pass loans, and
registered pensions. It’s a strange new world where providers of
such straightforward arrangements will now have to check in detail
to ensure they are not breaking the rules.
It is not enough to fall within the exceptions permitted; it
must also be demonstrated that no tax-avoidance motive is present,
as underlying this legislation is effectively a general
anti-avoidance rule on just about every activity mentioned.
At a time when the government is promoting simplification and
the removal of regulatory burdens on business, it is disappointing
that the new rules are so ill-defined. The approach taken has been
so Draconian and the weapon fashioned so blunt that it is often
difficult to see what is being aimed at. It’s a brave person who
tries to discern the spirit of the legislation, if indeed there is
one.
The trouble is, if we cannot exactly articulate the problem, we
cannot exactly articulate the solution. This may in part be the
reason for such excessive paperwork. How much better – if it could
be achieved – for this legislation to be reduced to a series of
clear, understandable rules? And this can be achieved with clear
policy and concise drafting. Let’s not do it this way again.
COMMENT – Wendy Walton TEP
New rules unfair and inconsistent
ABOUT THE AUTHOR: Wendy Walton TEP is STEP UK
Technical Committee Chair. The full comment, which was submitted on
9 February 2011, is online at
www.step.org/disguisedremuneration
STEP’s UK Technical Committee welcomed the chance to comment on
the disguised remuneration ‘Employment income through third party’
draft legislation, published on 9 December 2010, which is intended
to comprise a new Part 7A of the Income Tax (Earnings and
Pensions) Act 2003 (ITEPA).
‘We believe that the provisions relating to earmarking are
unfair and unworkable. We strongly urge the government to withdraw
these provisions and that they should be replaced with measures
that only impose tax when a legal right to money or assets is
obtained by the employee.
‘We believe that the impact of these measures, even if the
earmarking provisions are removed, will act as a disincentive for
businesses to enter into genuine employee benefit packages for
those employees who generate wealth for UK businesses and therefore
the UK economy.
‘This legislation is not consistent with other tax legislation
relating to benefits received by individuals from companies or
trusts. We strongly urge the government to rethink its approach in
this regard and to introduce, instead, a more logical, consistent
and fair set of rules. This should be based on the principle that
individuals should not be taxed unless they have a legal right to
an asset or a sum of money.
‘Furthermore, the basis of taxation should be on the benefit
actually received and therefore the provisions relating to the
taxation of loans and the provision of assets should be
substantially revised. The treatment under these provisions should
mirror those for the taxation of benefits from non-remuneration
trusts and/or benefits from employers when provided directly.
‘The rules should exclude all normal and genuine employer
incentive arrangements and any pensions which are already taxable
under ITEPA. All pre-existing schemes should be excluded, in
particular pre-A Day corresponding schemes as well as pre- and
post-A Day s615(6) schemes.’