Is HMRC correct in seeking settlement on the basis proposed ?
Warning: What follows is comment, not advice. No reliance should be placed upon the views expressed without first seeking specific advice in relation to particular facts.
HMRC are putting pressure on companies which have established EBTs and made contributions intended to provide rewards to employees by appointing such funds on (typically, revocable) sub-trusts for the employee and/or his family. Settlement is proposed on the basis that the company accepts that the appointment or transfer of funds to such a sub-trust 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 rate(s) prevailing at that time.
The only authority cited for this treatment in the FAQs, and in correspondence on specific cases, is the PA Holdings case. It is said, by HMRC, that “this 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”.
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 that the payments received by the employees were emoluments. The Court of Appeal has held that, as such payments received were emoluments, 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.
In the case of (many, if not all) EBT arrangements targeted for settlement by HMRC – at least, those in which the sums concerned remain held in the sub-trusts and have been invested, but not paid out to a beneficiary – the employees concerned will not have “received” any “payment”. The funds have remained held by the Trustee, albeit on (revocable) trusts for the benefit of the employee and his family. Income tax on earnings is charged on a receipts basis: see s 18 ITEPA 2003. In the case of employees who are not directors (to whom special rules apply), the time at which earnings are to be taken as “received” for income tax purposes is the time when “a payment is made of or on account of the earnings” (per Rule 1, s18) or, if earlier, when “a person becomes entitled to payment of or on account of the earnings” (see Rule 2). “Entitled to payment” in this context means “a present right to present payment” – per the UTT in UBS AG and DB Group Services v HMRC  (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, liability to income tax has already arisen (per ss15, 18 and 19 ITEPA 2003).
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 trustee exercises 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 trustee.
The recent Court of Appeal decision in HMRC vs Forde and McHugh Ltd is authority for the assertion 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 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”.
Pausing there, it would appear still to be good law that where a contribution was 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 he is incapable of turning such sums into money or money’s worth. If funds have been loaned to the employee or a family member there may be a questionmark as to whether the loan (if made before 10 December 2010) was in reality intended to be, and was in fact, a payment (if, for example there was no expectation that it would be repaid).
The decision in HMRC v Forde and McHugh Ltd is, authority for the assertion that contributions to such a fund may nevertheless be “earnings” for NICs purposes and that, accordingly, secondary Class 1 contributions are due from the employer on the amounts so contributed. The case involved a FURBs for an identified employee. There may well be arguments that differentiate a contribution to an EBT, or to a sub-trust of an EBT.
Even if HMRC’s assertion, that funds appointed to a sub-trust are “earnings”, is ultimately held by the Supreme Court to be correct in relation to a typical EBT arrangement, there is separate authority for the proposition that such a contribution or transfer does not amount to a “payment” of or on account of any such earnings, and therefore no liability to account for PAYE arises by reason of s686. Warren J, sitting in the Upper Tribunal in the Aberdeen Asset Management case, held that, for the purposes of s203B ICTA 1988 (now s 686 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 well 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.
It is not the purpose of this note to suggest that a settlement on the terms particularised in the recently published FAQs should not be considered. In many cases the credit available against further employment income tax (although not all income or other tax) charges on the funds, and any ‘growth in value’ of the funds, in the sub-trust may be of attraction, particularly in those cases in which the funds have not been paid or loaned out and have been invested for, and have generated, capital growth. For the employer, the certainty of a corporation tax deduction may be of attraction.
We are, however, aware of instances in which, for example, funds invested have suffered losses so the amount on which HMRC wishes to claim PAYE tax and NICs is greater than the amount now available to provide benefits to beneficiaries. In these and other cases, in which the sub-trust was intended to be a long-term fund for the provision of future benefits, sponsoring companies might wish to think long and hard before rushing to negotiate a settlement, given that HMRC may ultimately be held to be acting on an erroneous basis.
Careful consideration is also needed in those cases in which HMRC is out of time for protecting PAYE and NICs because it had sufficient information to make determinations or decisions for those years within normal assessing time limits, but accepted that no PAYE and NICs were due. A settlement will only afford credit (against Part 7A charges on payments out, etc) if tax has been paid in respect of agreed “earnings” for such ‘out of time’ years: see para 59, Sched 2, FA 2011; FAQ 3.10; and EIM 45940. If all allocations/transfers to sub-trusts were made in such “out of time” years, subject to concern over deductibility of the contributions for corporate tax purposes, there may be good reason to ‘stand and fight’ (although, conversely, if the funds have been invested successfully, payment of PAYE tax on “out of time” allocations may, if HMRC were to succeed ultimately before the Supreme Court, prove to have been a worthwhile “investment”!).
We would be pleased to afford advice and technical assistance to you and your clients in relation to the discussions, negotiation, and assessment of a settlement opportunity in relation to EBT arrangements of the type described above.
HMRC’s FAQs on the EBT settlement opportunity can be found by clicking here.