Employee benefit trusts provide a tax-efficient means to provide long term employee benefits and an alternative for pension provision but the Dextra case has raised some issues
EBTs as 'pension schemes'
Employee benefit trusts (EBTs) can be used to provide pension benefits. The EBT deed in MacDonald (HMIT) v Dextra Accessories Ltd  BTC 355 conferred upon the trustee a wide discretion over capital and income to pay money and other benefits (including pensions) to any of the named beneficiaries (the employees and their families) and a power to lend them money.
An EBT is in the form of a discretionary trust and can be used not only to benefit the employee but also his family both during the employee's lifetime and after his death.
The tax code for EBTs
There is no unified tax code in the UK for the taxation of EBTs. The tax treatment of EBTs can be drawn from the Dextra case (in which HMRC lost before the Special Commissioners and in the High Court and won in the Court of Appeal and the House of Lords) and the relevant sections of statute by analysis.
In Dextra, a payment had been made by an employer to a Jersey based EBT. HMRC raised various issues which were discussed and settled as the case moved through the Courts leaving the House of Lords to settle the final remaining point at issue: the definition of "relevant emoluments". The main issue was whether the employer could obtain a deduction in its corporation tax computation for payments to an EBT when there was no immediate assessment on the employee.
The issues in Dextra
The detailed implicit and explicit issues raised in the case are:
1. Is the use of EBTs tax avoidance or subject to Ramsay?
2. Are payments to and payments from the EBT subject to IHT?
3. Is there a concept of symmetry in UK tax law?
4. If the payments are not relevant emoluments, are they deductible for the employer under general principles?
5. Are payments to EBTs assessable on the employee?
6. Are transfers to sub-trusts for employees assessable as emoluments?
7. Are payments to the EBT "relevant emoluments" as defined by FA89 s.43 and therefore deductible for the employer only when paid to employees?
Issue 1: tax avoidance / Ramsay
Counsel for the taxpayer contended that:
This is not a tax avoidance scheme. The tax advantages of EBTs are part of advantages they have for rewarding employees - the end result here is that the funds are in trust, not that they are paid as emoluments or earnings. Where loans are made, which is to a limited extent - the loans are genuine loans on which interest is paid.
The Special Commissioners found:
"Applying a commercial approach [using the Ramsay distinction between legal and commercial concepts used in statute] to the relevant statutory concepts, in this case there was no payment of emoluments or earnings by reason of these particular arrangements involving the EBT. If it is necessary for us to decide it, we do not categorise the EBT as an artificial tax avoidance scheme."
Issue 2: is the EBT subject to IHT?
Generally employee trusts are exempt from IHT so long as all employees can benefit. In Dextra, the directors/shareholders were given retrospective benefits and other employees prospective benefits. HMRC argued that this meant that the EBT was solely for the directors' benefit. The Special Commissioners commented:
"There is a valid reason for the difference between past and future performance conditions in that the directors had no entitlement to salary during the current year and so they were receiving all of what would be their remuneration in arrear."
Although an EBT would qualify for the IHT exemptions for employee trusts, care must be taken that only the employee and his immediate family can benefit (there would be a problem if the EBT owns property and remote family and friends are allowed to stay there rent free) since otherwise the exemptions can be lost. The IHT analysis is complex and HMRC's position with regard to employers which are close companies can be found at http://www.hmrc.gov.uk/practitioners/macdonald-v-dextra.htm
Issue 3: symmetry
The issue of symmetry is whether all tax deductible payments for a payer should be assessable in an equal amount and at the same time on the payee.
The Special Commissioners commented:
"We quite understand HMRC not liking the asymmetry of the companies obtaining an immediate deduction for the payments into trust without any charge to tax on the employee except perhaps a charge to tax on interest-free loans at the official interest rate, and not even that if the official interest rate is paid, which we understood it eventually was on all the loans.
"However, it is in the nature of employee benefit schemes that the employer should obtain a deduction having paid away money to such a trust. The reason why the employees are not taxed on funds in the EBT is simply that they do not belong to the employees.
"The directors may have carried this to extremes by not taking any significant remuneration in cash but their position is entirely different from what it would have been if they had.
"Prior to 1989 employees were assessed on the accruals basis. Symmetry was therefore achieved under general principles. FA89 changed the employee basis to a payments basis but in order to retain symmetry FA89 s.43 was introduced which gave a deduction to the employer only if the payment of the amount accrued in the employer's accounts is paid within, or within nine months of the end of, the relevant accounting period.
Issue 4: are the payments to the EBT deductible under general principles?
This is the hub of the argument. If the payments to the EBT are not relevant emoluments as defined by s.43 then they are not subject to s.43's symmetry rule.
Since there is no general principle of symmetry in the UK tax code and they are paid for the benefit of employees (albeit subject to a performance test) they are paid wholly and exclusively for the purposes of the trade and are therefore deductible under Schedule D Case I.
Issue 5: are payments to the EBT assessable on the employee?
This issue was not raised as such but since the employee receives nothing they are not.
Issue 6: transfers to sub-trusts
As stated in January's article the use of trusts by individuals is now almost against public policy under the UK's tax code. However, the EBT remains a tax privileged vehicle and can be used to create an ongoing IHT exempt discretionary family trust which is taxed only when benefits are received by beneficiaries.
The issue regarding sub-trusts revolves around the decanting from the general EBT into sub-trusts within the EBT so that the trustees can pursue different investment strategies. HMRC argued that this decanting itself conferred a taxable benefit. The Special Commissioners disagreed on the grounds that the sub-trusts were revocable.
Issue 7: are transfers into the EBT relevant emoluments?
The issue here was summed up in the Court of Appeal as to whether: "the contributions to the EBT fell within s. 43. That in turn depends on whether those contributions, when received by the trustee constituted 'potential emoluments' as defined in s.43(11)(a), as being 'amounts… held by an intermediary with a view to their becoming relevant emoluments'. It is rightly accepted that the trustee of the EBT is an 'intermediary' for this purpose, so that the issue boils down to whether the contributions were held by the trustee 'with a view to their becoming relevant emoluments'."
That in turn depended upon the meaning of "with a view to". Given the wide discretion of the trustees the answer was 'no' and so no deduction was available.
EBTs continue to be a tax-efficient means of providing long term employee benefits and an attractive alternative means of pension provision.
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