EBTs and disguised remuneration – Jo Summers
Jo Summers of PWT Advice LLP specialises in personal taxation for individuals , in particular those who move to and from the UK. Jo was asked by Ann for her thoughts on the hot topic of the disguised remuneration rules as they apply to Employee Benefit Trusts.
The views expressed here are Jo’s and do not necessarily reflect those of Ann.
Since the introduction of the disguised remuneration rules, now found in Part 7A of the Income Tax (Earnings & Pensions) Act 2003 (‘ITEPA’), many companies are faced with a problem about what to do with their Employee Benefit Trust (‘EBT’).
In the ‘good old days’, a company’s EBT could be used to provide benefits and loans to employees, often in a very tax efficient manner. Many of these options were restricted by the introduction of Part 7A ITEPA, particularly the ‘earmarking’ charge in section 554B which triggers an immediate charge to income tax and NICs whenever anything is earmarked for an employee, however informally.
Should companies keep their EBTs going (if so, for what purpose?) or should they wind them up (if so, how?).
The key questions are:
1. What in light of Part 7A can an EBT still do?
2. What can an EBT not be used for? and
3. How do you wind up an EBT?
What can an EBT still be used for?
EBTs still work with most share, deferred cash and phantom share plans. This is for two reasons. First, if the trustees are not aware of who the particular beneficiaries are (a ‘blind trust’) no earmarking charge will arise if the EBT acquires shares or cash to satisfy future awards. Second, there are many exemptions for specific plan arrangements. Obviously care is needed if any exemption is relied on, in order to comply with the detailed requirements, particularly with vesting and forfeiture terms.
Also many companies continue to use EBTs to set aside a pot of shares for their employees on exit, to create an internal market in the company’s shares, to hedge against share price increases, to reduce the dilution cost of share plans and to provide discretionary bonuses.
What can an EBT not be used for?
Historically EBTs were used for tax planning, particularly by making loans on ‘soft’ terms to beneficiaries or by placing assets into sub-trusts for a particular beneficiary and his/her family.
Under Part 7A, any loan from an EBT will be subject to the same immediate income tax & NIC liabilities as an outright bonus. Worse, there is no way of reclaiming that tax, even if the loan is later repaid.
Further, if any part of the EBT assets are allocated or set aside in some way, whether by way of a formal sub-trust or otherwise, this is likely to constitute “earmarking” (unless one of the specific exemptions applies) and again triggers an immediate charge to income tax and NICs. Sub-trusts established prior to 6 April 2011 may be grandfathered to an extent, as will any income arising on those previously earmarked funds. However, any new relevant step (e.g. a new loan to a beneficiary) will be caught by Part 7A.
If an employer has only ever used its EBT for the provision of loans to employees, the employer should consider making the loans directly to the employees. Employer loans are still subject to the more benign beneficial loan regime (although there are Consumer Credit Act issues to consider).
Winding up the EBT
EBTs come with ongoing administration costs. Some companies may decide there is little merit in paying the costs of running the EBT, post Part 7A ITEPA, if they cannot make loans to employees or use sub-trust arrangements.
The question then is how to wind up the EBT and here there is a sting in the tail: the cost of winding up the EBT may be greater than the cost of keeping it going. The biggest problem will be those EBTs that do not have liquid assets, perhaps because all the funds were lent to beneficiaries and those loans are still outstanding. Any change to the existing sub-trust arrangements or any loan waiver will trigger a Part 7A charge. There may also be inheritance tax issues on assets leaving the EBT, particularly on loan waivers, under section 72 Inheritance Tax Act 1984.
Otherwise, if there are any assets left in the EBT, perhaps these can be used up over time by making discretionary bonus payments or paying for other non-contractual benefits for employees (e.g. additional medical insurance). Making these payments from the EBT saves the employer money and eventually will allow the employer to wind up the EBT.
Jo Summers is a solicitor and founder of PWT Advice LLP. PWT provides advice on personal taxation, pensions, trusts, and employee benefits as well as probate, wills and charity law. To contact Jo by email please click here.
*** UPDATE – May 2015 ***
To read a related blog post which assesses the tax position of EBTs after the end of HMRC’s settlement opportunity (EBTSO) please click here.