EBTs: an update after the end of EBTSO – Jo Summers and Jeremy Glover

Jo Summers of PWT Advice LLP specialises in personal taxation for individuals and she produced a guest post last year on EBTs and disguised remuneration. She was asked to write a follow up post which was written with the help of her colleague, Jeremy Glover who is an expert in employee benefits, in particular, EBTs.

The views expressed here are Jo’s and Jeremy’s and do not necessarily reflect those of Ann.

HMRC withdrew its Employee Benefit Trust (‘EBT) Settlement Opportunity (the ‘EBTSO’) earlier this year. Until 31 March 2015, HMRC were offering employers of beneficiaries under EBTs a way of settling the uncertainty relating to the taxation of the EBT.

Such uncertainty might relate to HMRC’s stated opinion that the creation of sub-trusts, or the making of loans, to beneficiaries always constituted the making of a taxable distribution to the beneficiary. Both of these steps are specifically taxable if taken after the introduction of the disguised remuneration rules (now in Part 7A of the Income Tax (Earnings & Pensions) Act 2003 (‘ITEPA’)).  In other words, HMRC was using the EBTSO effectively to backdate the effect of Part 7A.

Some companies decided not to settle under the EBTSO. In other cases, the companies have gone into liquidation. This doesn’t mean that nothing can be done. Often, in return for a payment of corporation tax, HMRC have shown willing to agree a quid pro quo.  In some cases, this might mean letting a beneficiary treat the loan as having been waived, in other cases we have even seen HMRC agreeing that transactions with the EBT could be completely reversed.

For example, we had direct experience of a case where the major shareholder in the employer company had transferred his shares into the company’s EBT. The thinking at the time was that the EBT (being based offshore) could then sell the shares tax-free.  Whilst this is still correct, clearly there is now an issue with how the shareholder can benefit from the sale proceeds. As a participator in the company, the shareholder could only receive income benefits, which would now be subject to PAYE under Part 7A.  In other words, the shareholder had converted his liability to capital gains tax on sale of the shares (at a maximum of 28% and quite possibly at 10% if entrepreneur’s relief applied) into a liability to income tax and NICs at over 50%!

HMRC agreed that, as part of the EBTSO, they would treat the transfer of shares as if it had never actually passed beneficial ownership to the EBT. The trustees were therefore holding the shares as nominee and the shares could be returned to the original shareholder without any tax charge arising.

Whilst this may sound a remarkable position for HMRC to take, in fact it merely reflects the outcome of a string of cases where the Courts have unwound EBT structures based on the equitable doctrine of mistake. Mostly these cases have found their way into courts outside the UK, such as those of the Channel Islands, as that is where the EBT trustees are based.

The arguments have been similar in each case. The person who made the transfer to the EBT argued that they would never have done so if they had fully understood the tax consequences of the transaction. Mostly this related to the UK tax rules on how participators in the employer company can benefit. As noted above, any participator in the company has to be excluded from benefit, other than benefits that would be taxed as income in the participator’s hands.

This is as a result of sections 13 and 94 IHTA 1984. It seems many shareholders were unaware of this rule, or failed to appreciate what it meant, when the EBT was set up or when they transferred their shares to the EBT.

So despite the official withdrawal of the EBTSO, HMRC seem to be happy still to discuss EBT tax situations and the courts continue to hear mistake cases, which HMRC will be well aware of.

In addition, HMRC are more aware of the different ways an EBT can be taxed. Recent correspondence shows HMRC are now more willing to look at the inheritance tax aspects of an EBT. Normally an EBT is exempt from inheritance tax, because of the statutory exemption in section 86 IHTA 1984. However this exemption only applies where the EBT is ‘for all or most of the employees’ of the company.

HMRC’s view is that sub-trusts for individual employees and their families do not qualify for the section 86 exemption. There is also an exit charge in section 72 IHTA 1984, which applies where funds come out of an EBT otherwise than as an outright distribution to a beneficiary (on which income tax and NIC are payable). We have seen HMRC pick up on this section 72 charge, which is payable by the EBT trustees, where funds have been put into sub-trusts or where loans have been waived post the borrower beneficiary’s death.

So the uncertainty relating to the taxation of EBTs hasn’t yet been resolved, despite the EBTSO ending in March of this year.

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 or to contact Jeremy please use this link.