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Employee benefit trusts ('EBTs'): HMRC'S challenge – and the 'settlement opportu

HMRC has published detailed FAQs relating to the ‘settlement opportunity’ afforded to employers who have, for example, used EBTs as the mechanism for providing benefits by way of contributions to an EBT and the subsequent appointment or transfer of funds to a sub-trust (or sub-fund). 

It is reported that, for example, J P Morgan has chosen to reach agreement with HMRC for settlement of tax and NICs on contributions made to EBTs for its c. 2,000 UK employees dating back to 2005.  We are advising a number of companies in negotiation with HMRC exploring the benefits of a settlement.  Do call us if you are considering such a settlement.

Does HMRC have a sound legal basis for the assertions made to justify its challenge and the grounds for settlement?

HMRC are citing their victory in the PA Holdings case as authority for justifying their view that companies with such EBT arrangements should negotiate to settle liabilities to income tax and NICs on the basis that the company accepts that the appointment or transfer of funds to such a sub-trust or fund is properly to be treated as a payment of earnings on which income tax and NICs is due under PAYE at the time of such appointment or transfer and at the rates prevailing at that time. HMRC assert that “[the PA Holdings case] supports the view that the taxing statutes impose a tax in relation to the source of the income, rather than the form in which it is delivered”. This is true, but, that case relates to a scheme under which bonuses were paid to, and were received by, employees in the form of dividends on shares in a specially-formed company funded through an EBT. 

The tribunal found as a fact that the payments received were emoluments. The Court of Appeal later held that, as such, they fell to be charged to tax as earnings, not as dividends. However, the key point is that, in that case, the funds involved were in fact paid to, and received by, the participating employees shortly after the funding contributions were made by the company. The difficulty for HMRC is that in many cases the employees concerned will not have received any payment : the funds will have remained in the trust or fund, albeit on revocable trusts for the benefit of the employee and his family. Income tax on earnings is charged on a ‘receipts’ basis : section 18, ITEPA 2003. Earnings are generally taken to be received when a payment is made of or on account of the earnings” (per Rule 1 of s18) or, if earlier, when “a person becomes entitled to payment of or on account of the earnings” (per Rule 2). “Entitled to payment” in this context means “a present right to present payment” – per the UTT in the UBS/Deutsche Bank case (and see EIM 42290). It is a question of fact in each case as to whether an employee has acquired an immediate entitlement to payment of a bonus before the sums are allocated or transferred to sub-trusts. If so, a liability has already arisen (per ss 15, and 18, ITEPA). It is far from established that, where such a liability has not already arisen, a transfer of cash to a sub-trust under which an employee (and members of his family) has only a hope or expectation of benefit if or when the trustees exercise a discretion in his or her favour, and subject to there being no revocation of the sub-trust, is itself a “payment of , or on account of, earnings” or that the employee thereby becomes “entitled to payment of earnings”. The employee normally has no present entitlement to any such present payment – that is at the discretion of the trustees.

The Court of Appeal decision in HMRC v and McHugh Ltd is authority for the proposition that “payments [made] into a fund in which the employee has only a conditional or contingent interest [are not] part of the employee’s emoluments for tax purposes”. Arden LJ, giving one of the majority judgements, accepted that, so far as the tax (as opposed to NICs) legislation is concerned “that is because the payments [to the fund] were not in the nature of a salary, fee or wage, nor were they a perquisite or profit for tax purposes because they were incapable of being converted into money even though they were of value to the employee”. Indeed, Arden LJ “did not understand the Revenue to submit otherwise”. It would therefore appear still to be good law that where a contribution has been made to an EBT, and a subsequent appointment of the funds was made to a revocable sub-trust for a named employee and his family, such sums are not “emoluments” and, accordingly, not “earnings” of the employee for the purposes of income tax if the employee is incapable of turning such sums into money or money’s worth.

Even if the Supreme Court does ultimately hold that a contribution to such a sub-trust or fund is properly to be treated as “earnings” for income tax purposes, there is separate authority that such a contribution does not amount to a “payment” of or on account of any such earnings for the purposes of PAYE. Warren J, sitting in the Upper Tribunal in the case of Aberdeen Asset Management PLC v HMRC – see further below – has held that, for the purposes of s203B ICTA 1988 (now s686 ITEPA 2003), which relates to the point in time at which PAYE is due on certain payments of earnings (and which mirrors s18), “payment” refers to an emolument in the form of money. Whilst the contribution may be in the form of a cash payment, it does not follow that the employee thereby receives, or becomes entitled to, a “payment” in any form.