News and Insights
18 December 2018
Employee Benefit Trustees await developments as the 5 April 2019 deadline looms.
There are plenty of circumstances in the world of commerce where the flexibility of a discretionary trust and the gap between an employer as settlor and its chosen trustees have also proven useful. Employee Benefit Trusts (“EBTs”) are an excellent example of this.
What are EBTs?
In the popular imagination trusts are used to manage the fortunes of rich families, for example by planning for inheritance tax and keeping the black sheep of the family on a short rein. However there are plenty of circumstances in the world of commerce where the flexibility of a discretionary trust and the gap between an employer as settlor and its chosen trustees have also proven useful.
Employee Benefit Trusts (“EBTs”) are an excellent example of this. They are trusts an employer can set up by giving to the trustees assets, (such as shares, share options or simply cash) to share out among its employees as the circumstances recorded in the trust documents allow. The trust fund is thus moved off the books of the employer and the prospect of rewards if conditions are met or discretions are exercised can help to incentivise employees and to retain quality staff.
EBTs commonly take the form of discretionary trusts of which all of the settlor’s employees (or its group) are beneficiaries. The trust fund will consist of assets from which benefits for the employees can be distributed. These benefits include:
- Cash payments ( either as outright gifts or as loans made on favourable terms)
- Outright gifts of shares.
- Conditional or restricted gifts of shares.
- Share options – the chance to buy shares, generally on favourable terms.
How have EBTs been used?
The assets of EBTs are subject to the usual rules of taxation upon income and capital gains, so for example the trustees of EBTs pay income tax on the trust’s UK source income and pay capital gains tax on increases in the value of the UK located capital assets they hold.
During the 1990s and 2000s, it was commonplace for employers to pay bonuses awarded to employees not directly to them but into offshore EBTs. The funds could then be made available by the trustees to the employee beneficiary in the form of an interest free, unsecured loan with no fixed repayment date. This had the effect of giving employees access to their award without first having to pay tax on it, a tactic often referred to as disguised remuneration.
Round one: the Finance Act 2011
The Finance Act 2011 recognised and acted against this loophole. Disguised remuneration rules were introduced to ensure that employees were taxed on sums loaned to them by the trustees of their EBT as if it were normal employment income, with no refund of the tax paid allowed, even if in fact the loan was eventually repaid. The Finance Act 2011 did not operate retrospectively, so arrangements made before 2011 were not subject to its provisions. HMRC therefore decided to cast its net once again, this time using one with a tighter mesh.
Round two: the Finance Act 2017
Under the provisions of the Finance Bill 2017 any EBT loans ( whenever made ) from trustees to beneficiaries still outstanding ( i.e. owed by the employee / beneficiary to the trustee ) on the 5 April 2019 will be subject to income tax and national insurance charges just as the employee’s ordinary salary would have been. This gives the Finance Bill 2017 retrospective effect in that it applies to loans that were made and that have not been repaid before it comes into effect on the 5 April 2019.
There may be exceptions to these charges if;
- The loan has been repaid in full (but official policy on this issue appears to be evolving)
- The loan has already been taxed in full under the disguised remuneration rules (updated in 2016)
- Any exclusions apply.
- The loan was made from a fund on which income tax has already been paid.
Options for dealing with the unexpected
Certain tensions are arising because the most obvious way to manage the charge arising may be to repay the loan, but many beneficiaries received their loans thinking they would never need to be repaid and so planned their affairs accordingly.
Furthermore many companies and employees which have used EBTs have been approached by HMRC regarding their tax position. Currently three options are being offered:
- Trying to reach settlement with HMRC
- Waiting for the outcome of litigation that may be brought by other interested parties
- Pursuing appeals on a case by-case basis
The settlement option may, on the face of it, look the most attractive and HMRC has already put forward a settlement opportunity, allowing employer companies to negotiate and pay any outstanding tax liabilities. It may publish other similar opportunities prior to the 5 April 2019 deadline. However this is not certain and besides the settlement option has its own complexities.
Employer companies faced with this tax bill may approach the beneficiaries (i.e. its current or former employees) who after all received the money in question, to indemnify it for the expense thus incurred. These employees, and especially former employees, are questioning if there is any legal duty upon them to pay such indemnities. Their employers may then be tempted to respond by seeking to place indirect pressure upon them by urging their creditor trustees to seek a full or partial repayment of the “loan” originally made. All three parties have rights and duties that need to be analysed and then exercised or performed with great care in the light of the available documentation and other evidence.
We are able to advise the trustees and beneficiaries of Jersey law EBTs on the various options to them when addressing the Finance Bill 2017 so that, in combination with their UK tax advice, the right way forward can be identified.