New HMRC pronouncements on EBTs: what they really mean
On 31st March HM Revenue & Customs published proposed new regulations creating a charge to income tax when assets are earmarked by trusts or other third parties for the benefit of employees. In our April Newsletter we made it clear why, despite the length and complexity of these measures, they will make little difference to the operation of bona fide employee share schemes.
HMRC has now returned to the fray with a new brief, 18/11, on the subject of income tax and inheritance tax in relation to Employee Benefit Trusts (EBT). EBTs have clearly become a favourite for HMRC attack and the wording of this latest brief is suitably magisterial in tone.
Interestingly, however, brief 18/11 seems to confirm that certain contributions to trusts, which would otherwise incur an inheritance liability (1), can escape the liability if there is no gratuitous intent. The contributions which are normally caught for IHT purposes are those made by close companies (2) to trusts where a participator can benefit (broadly a holder of 5% or more of the share capital).
In the past, we had thought it safe to assume that gratuitous benefit would include anything paid by way of reward for services (much in the same way as a tip in a restaurant). On this interpretation, the exemption would rarely apply. However it now seems that HMRC accepts that gratuitous does not include anything that is a genuine, arm's length reward for services. On this basis it would seem to be acceptable for close companies to pass contributions to EBTs, from which participators can benefit, as long as the amounts are paid out as an arm's length reward for services.
Making it up
HMRC counters this by saying that there should be both an objective and subjective test to determine whether a gratuitous benefit is intended. HMRC seems to believe that these tests represent a difficult hurdle for companies. However, the tests have just been made up by HMRC and are therefore of doubtful relevance. In any case the tests are not hard to satisfy. Apparently, the subjective test is met if there is not the slightest possibility of gratuitous intent. This should be easily met by the appropriate drafting of board and trustee minutes (3). The objective test requires that the transaction must be at arm's length. Again, not a difficult test to pass.
There is another exemption available for contributions to an employee trust where a corporation tax deduction is available on the contributions. HMRC states that the exemption will not be available unless the corporation tax deduction is available in the same year as the contribution. The legislation contains no such requirement. Once again HMRC is pushing the boundaries in order better to attack its sworn enemy, the employee benefit trust. Hopefully this interpretation will be tested before too long before the Tax Tribunal.
If you would like more information on the matters raised in this memorandum please call us on 020 8949 5522 and ask to speak to one of our advisers.
(1) At the lifetime rate, currently 20%. No immediate charge will arise if the amount (together with other taxable amounts) is within the lifetime IHT exemption, currently £325,000, but the amount of exemption at death will be correspondingly reduced.
(2) Broadly, a company controlled by five or fewer individuals.
(3) HMRC seems to imply that the discretion of the trustees must remain unfettered and therefore a possibility of gratuitous benefit could still exist even if not intended by the settlor. We can find nothing in the legislation that prevents discretionary trusts from accepting settlements with conditions attached.