Employee Benefit Trusts – HMRC attacks strengthened with Rangers result
This blog has been reproduced with the kind permission of Jeremy Glover of Jurit Law.
Employee Benefit Trusts are constantly under attack by HMRC. Many are restricted in their operation as a result of Part 7A Income Tax (Earnings and Pensions) Act 2003 in that many actions that EBTs used to take are now considered to be taxable “relevant steps” for the disguised remuneration provisions in that Part to apply. HMRC continues to challenge even steps that pre-date the introduction of the disguised remuneration rules on a number of bases, including that one of the actions by the employer or trustee must itself constitute earnings and be subject to employment income tax on first principles, even without the disguised remuneration provisions. For these, pre-disguised remuneration, EBTs HMRC has previously argued in court cases that the employee should be liable to employment income tax when funds are allocated to sub-trusts in the names of the employees. Those arguments have not previously succeeded, because the monies in the trusts are not completely at the disposal of the employee and therefore cannot be treated as employment income unless and until distributed to employees.
The Court of Session in Scotland has now handed down a decision that has the potential for wider application than was expected. In a change to its usual tactics, HMRC argued that contributions to an EBT themselves amounted to payments of earnings, even before they were allocated into sub-trusts. The Court agreed with HMRC and held "that the sums received by the trustee of the Principal Trust, and in due course by the trustees of the sub-trusts, amounted to a mere redirection of income and thus constituted emoluments or earnings of the employees in question”. This approach seems to focus (inconsistently with other recent case law) on what the employer pays, rather than what the employee receives. Tax practitioners would usually say that there can only be a “redirection” of earnings if the employee is legally entitled to those earnings and directs that they be paid elsewhere; and that this should not be the case with a purely discretionary EBT contribution, where the employee is only ever entitled to receive (and only does receive) the limited rights of a potential trust beneficiary and the hope that the trustee will exercise discretion in his favour.
The Court's approach has implications that go beyond EBTs – indeed, the Court seems to suggest that if any amount is paid (no matter to whom) in respect of an employee's work, then the employee should be taxed on it. If that is right, the consequences are at odds with the rest of the tax code: for example, it is difficult to see how an employee could ever derive a tax benefit from salary sacrifice arrangements, or why we need the bulk of the benefits code. It is expected that the Court's decision will be appealed.
Those who are in the position of negotiating with HMRC in respect of an EBT should consider their facts, in particular the relative strength or weakness of any “redirection” argument, and consider to what extent they can differentiate their circumstances from the facts in the Rangers case. If there are clearly facts which show that the employee was in reality redirecting something already earned, then it is likely that the EBT arrangement was defective from the outset (and the Rangers decision does not change this). However, if there was no “redirection”, as it was understood prior to the Rangers decision, it is likely that there will be a tough battle with HMRC – at least until the Supreme Court has considered the matter.