Failed EBT scheme results in double taxationby
As HMRC opens a consultation into the taxation of employee ownership trusts and employee benefit trusts, a recent tax tribunal spotlights how taxpayers are using the schemes to avoid tax – except this failed scheme resulted in double taxation for the taxpayer.
Employee benefit trusts (EBTs) can be a tax-efficient mechanism for rewarding employees, often in the form of shares but also through cash bonuses and other benefits.
The disguised remuneration legislation has successfully closed down the advantages of most abusive schemes but we have seen several recent cases involving the use of EBTs that pre-dated the full force of the anti-avoidance legislation.
At the same time HMRC has opened a consultation on:
- proposals to ensure that the tax reliefs associated with Employee Ownership Trusts (EOTs) meet the policy objectives underpinning those reliefs; and
- proposals to reform the inheritance tax treatment for EBTs.
Recent HMRC win
As an example of the type of schemes HMRC is cracking down on, a recent first tier tribunal judgment involved a novel arrangement aimed at avoiding tax through clever use of an EBT which ultimately failed, resulting in double taxation – quite the opposite of the taxpayer's intention!
The basic idea seems to have been to use the company’s value to create a credit balance on a director’s loan account that could then be drawn down by the director without any tax or national insurance contributions.
It is worth noting that the company did not seek a corporation tax deduction for its payment of the amount contributed to its EBT.
In November 2010 M R Currell Limited, 'the company' transferred £800,000 into an EBT with the purported intention of ring-fencing the money to pay staff bonuses.
The source of the £800,000 was a loan to the company made by Mrs Kimberly Currell. Mrs Currell was a director of the company and (before these transactions) held 31% of the shares. Her husband, Mr Mark Currell, was the managing director and also, initially, held 31% of the shares.
Mark Currell bought shares valued at £800,000 from his wife and this enabled her to make the loan to the company. The source of the £800,000 used by Mr Currell to buy his wife’s shares was an interest-free, five-year loan of £800,000 made by the EBT set up using the same £800,000 provided by Mrs Currell.
The end result was that the company ended up with an EBT for the benefit of its employees funded by a loan from Mrs Currell and Mr Currell ended up with £800,000 borrowed from the EBT with no tax consequences at all. The benefit to the couple would have been that Mrs Burrell could then draw down the loan account, again with no tax consequences.
If, without the use of the EBT, Mrs Currell had made a loan to the company and the company had made a loan of £800,000 to Mr Currell then the company would have had to pay corporation tax under s455. Mr Currell would have also had to pay income tax on the benefit of an interest-free loan.
The FTT noted that it was a “neat tweak” in the arrangements that Mr Currell used the loan to buy his wife’s shares since a loan to purchase shares in a close company is not subject to the benefit in kind charge.
The question for the FTT was whether the £800,000 should be treated as earnings for Mr Currell and subject to PAYE of £320,000 and £113,427.33 of national insurance.
A genuine loan or remuneration?
HMRC's position was that the sum was paid to the EBT to reward Mr Currell for his services as a director over many years in building up the business. In that time he had taken relatively little in the form of salary or dividends.
The company argued that a genuine loan, repayable in the short term, could not be treated as a reward or benefit.
It was accepted by both sides that the loan was genuine and that Mr Currell had both the intention and the funds available to repay it.
The reason it had not been repaid in 2015, when the five-year period ended, was that HMRC had already opened an enquiry into the arrangements at that point and the taxpayers were concerned about potential double-taxation. Had the money been repaid to the EBT and used to pay staff bonuses, as indeed £50,000 of it was in 2019, it would be subject to tax on those bonuses.
However there is no law against treating loans to participators as remuneration. After consideration of the facts and relevant cases such as Rangers and the Baxendale Walker cases, the judge found that the payment was "more likely than not" made to Mr Currell as a reward for his services to the company and dismissed the taxpayer's appeal.
As a result, the £800,000 will be subject to taxation not just once but twice! First as remuneration paid to Mr Currell and again when it is paid out as bonuses to staff from the EBT. The company would have been better off had bonuses and director's remuneration been paid as normal, without the use of any scheme.
The judge had little sympathy for this, calling it a "consequence of the arrangements put in place by the appellant".
This outcome demonstrates HMRC's commitment to ensuring that EBTs remain focused on engaging and incentivising employees and deterring arrangements that seek to obtain tax advantages outside of these intentions.
You might also be interested in
Consulting Tax Editor for AccountingWEB.
I have spent the last 10 years teaching the accountants of the future, mainly ICAEW advanced level corporate reporting. I also cover tax news and write and edit tax updates for other publishers including PTP Limited.