Employee benefit trusts loans: new treatment by HMRC

employee benefitsUnder measures proposed in the Finance Bill 2017, HMRC will be able to turn back the clock and tax all but the oldest outstanding loans made by employee benefit trusts (EBT). This will be on the basis that a non-repayable loan is not a loan but is disguised pay.

The new rules allow distributions from an EBT or a similar structure to be taxed as income from employment, meaning they will be liable for income tax and national insurance contributions. The changes will apply to any outstanding loans made since 6 April 1999 and will be extended until April 2019, even if there has not been any distribution from the EBT.

What is an EBT?

An EBT is a trust that can be established either in the UK or offshore by a company to hold cash or other assets for the benefit of employees. The purpose of the trust is to incentivise employees and help retain quality staff by providing a benefit to them and their families, if certain goals are met.

The beneficiaries of an EBT can be past and present employees of the company, their families and their dependents. As EBTs are flexible, both share-based and cash-based benefits can be given. This includes:

  • cash payments
  • conditional share awards
  • restricted share awards
  • share options

The role of trustees

An EBT and the company that creates it are two separate legal entities. This means that once the company has transferred property into the trust, it will be run by trustees who have ultimate control over trustee property. The trustees are independent and can be paid for the service they provide.

It is the job of the trustees to distribute the trust, although they will often be guided by recommendations from the company as to how they should do so. That may include suggestions about the type of assets EBTs should hold, or when benefits should be granted to employees who have achieved particular benchmarks. It is also common for trustees to be asked to satisfy awards that have been granted to employees by the company.

As the trust is a separate legal entity from the company, it will continue to exist even if the company has a change of ownership or is wound up and liquidated. 

Taxing EBTs

The trusts are subject to the normal rules for taxation of trust income and capital gains. For trusts held in the UK, the trustees are subject to tax on income of 20 per cent and a 28 per cent tax on capital gains arising from the trust, if it included residential property.

During the 1990s and 2000s, it was quite common for employers to pay bonuses to their employees by transferring the award money to an offshore employee benefit trust. The funds could then be allocated to employees in the form of an interest-free loan which was to be left outstanding indefinitely.  In some cases, employees then accessed the bonus immediately, without paying tax on the amount.

In the Finance Act 2011, the disguised remuneration (DR) rules were introduced to ensure that the employees were taxed on EBT loans as employment income, with no refund of the tax if the loan was eventually repaid. However, at this point, the DR regime did not apply to EBT loans that were made before the 2011 Finance Act came in. Since then, HMRC has continued to take legal action against employers and employees and encourage them to sign up to a ‘settlement’ opportunity. However, it was not until the Finance Bill 2017 that the law was finally changed.

What are the options for companies with outstanding EBT loans?

To meet its objectives, the incoming government legislation means that if you have used, or continue to use a DR scheme then all loans will be taxed as earnings if they have not already been taxed on or before 5 April 2019. In August 2016, HMRC published terms available to employers who had used a DR scheme if they wanted to settle before 1 April 2017, when a statutory relief was withdrawn.

A charge will not apply if by 5 April 2019:

  • the loan has been repaid in full
  • the loan has been taxed in full under the disguised remuneration rules, as updated in 2016
  • any exclusions apply
  • the loan is from an amount on which income tax has already been paid

Many businesses will have already received letters from HMRC about EBTs, which will include an invitation to contact HMRC to settle any tax liabilities that may result from the use of an EBT. There are currently three options a company with tax owing on an EBT could take:

  • trying to reach a negotiated settlement with HMRC
  • waiting for the outcome of the litigation
  • pursuing appeals on a case-by-case basis

Businesses would be wise to seek professional advice and seriously consider the particular circumstances surrounding their case before they decide which course of action to take. 

A settlement may not always be the best route

Since settlement terms were published in August 2016 for firms wanting to settle before 1 April 2017, HMRC has not published another settlement opportunity. However, it has said that it will publish high-level settlement terms later this year. This would allow them to pay any outstanding liabilities and avoid litigation. However, while many employers will clearly be tempted by this option to remove the risk of litigation, it needs careful thought.

The complexities of a settlement could make this course of action a costly and unattractive option to take. In making a settlement, it’s likely that companies will look to the trustees and beneficiaries to contribute to the tax liabilities; but in reality, these payments could prove to be difficult to recover. This is likely to be the case with former employees and where assets have been loaned from the EBT. If the liabilities cannot be recovered, the business will be potentially left with the additional cost of a partial settlement in respect of certain beneficiaries only.

However, if they take no action then the loan charge will arise and employers will have the same issue of being unable to recover the tax from the employee. For that reason, some companies that have implemented the EBT properly and the benefits are subject to the relevant taxes under the disguised remuneration rules, it could be that their case is able to withstand the litigation.

If the settlement opportunity is not taken and a loan is still withstanding by 5 April 2019, and tax has not been paid, presumably the taxpayer will be given an opportunity to reach a time to pay agreement. However, interest will be charged.   

About the author

Written by Simon Renshaw, director at AABRS.