Companies which have in the past used an Employee Benefit Trust as a vehicle for providing bonuses to employees, and which have resisted settling claims from HMRC for PAYE tax on amounts paid to the trustees, should be concerned by HMRC’s recent victory over the Murray Group in the Court of Session in Scotland (equivalent to our Court of Appeal) relating to Glasgow Rangers Football Club (AG for Scotland v Murray Group Holdings Ltd (and others)  CSIH 77).
This long running case relates to a claim by HMRC for income tax under PAYE and NICs on a number of companies in the Murray Group, the former owner of Glasgow Rangers, prior to its liquidation in 2012.
The use by Glasgow Rangers of Employee Benefit Trusts
Very broadly, the football club established a practice of remunerating footballers and other employees by means of cash contributions to an Employee
Benefit Trust (EBT) that, in turn, established and funded sub-trusts for the benefit of each individual’s family.
The sub-trust would then advance funds to the individual at a commercial rate of interest but on a discounted basis. (The intention of this feature being to reduce the value of the individual’s estate for inheritance tax purposes on death.) The individual was appointed a ‘protector’ of the sub-trust with a power to vary the beneficiaries, and appoint and remove trustees.
The operation and benefits of using a trust were explained to each individual as being, in particular, that it would result in the receipt of a greater cash sum than if he received payments subject to PAYE, but that being a protector conferred no absolute beneficial right on the employee to such sums. While the trustees of the principal trust had a discretion as to the creation of sub-trusts, they invariably did so when asked.
The club paid annual bonuses that were discretionary and paid, in whole or in part, through such a trust arrangement.
Background to this judgement
It was found as a fact by the First-Tier Tribunal that such payments were entirely discretionary : the employee had no immediately enforceable contractual right to any such payment, although there was a clear expectation that he would receive remuneration for his services in this manner. Payments were made to the principal trust only after the views of the employee had been canvassed.
The Court of Session held, overturning the judgement of the Upper Tribunal, that the payments made by the employer to the principal trust fell to be charged to income tax as ‘earnings’ or (pre-2003) ‘emoluments’ of the employee. The employee had simply re-directed the payment of what were earnings or emoluments of his employment.
The court took the view that the payments, by the club to the principal trust, were earnings. The amounts were paid because the employee worked for the club: ‘any contrary argument seems an affront to common sense’.
The court’s reasoning appears to be that a payment was made by the employer by way of the discharge of the employer’s obligation to the employee. Regardless of the person to whom it was made, the fact that it was made because of the services rendered by the employee, and available for the benefit of persons chosen by the employee, means that the payments were properly to be considered as taxable earnings or emoluments of the employee.
Section 18(1), Income Tax (Earnings & Pensions) Act 2003 (“ITEPA”) contains rules for determining the earliest time when ‘money earnings’ fall to be charged to income tax. Rule 1 is when payment is made of, or on account of, the earnings, and Rule 2 is when the employee becomes entitled to payment of, or on account of the earnings’. UBS AG v HMRC  STC 2278 (CA) is authority for the proposition that “entitlement” for these purposes means a ‘present entitlement to immediate payment’.
The judgement of the Ct of Session raises the question as to whether a payment by an employer should properly be treated as ‘earnings’ (before then applying the rules in s 18 to determine when it falls to be charged to income tax) if, notwithstanding the fact that the payment is ‘for’ or ‘in recognition of’ the services of the employee, the employee himself neither receives, nor has any immediately enforceable right to receive, this form of salary, fee, gratuity, profit or any other form of incidental benefit being the money or ‘money’s worth’ (which ‘earnings’ is defined to include – see s 62 ITEPA).
Whilst one might say that a ‘gratuity’ is clearly ‘earnings’, that would presumably only be the case if and when it is paid, or the employee becomes immediately entitled to it. That was not so in the present case.
The rationale of the court
The Court of Session regarded the employee as becoming taxable because there was a payment of ‘money earnings’ by the employer, per Rule 1.
The payments made by the employer to the principal trust were, it held, ‘earnings’. They were payments made for the services of the individual employee as they were derived from the employee’s services as an employee (paragraphs 56 and 58); they were the product of the employee’s work (paragraph 53). Although they were discretionary, they were derived from and based on the work done (paragraph 59); they amounted to the ‘discharge of an employer’s obligation to an employee’ (paragraph 60); and ‘any [such] obligation was created by the decision of the employer to pay a bonus in recognition of work performed’ (paragraph 59). The employee had chosen to redirect that part of the consideration for his employment, in this case, to the trustees.
Put another way, perhaps: the amounts concerned were (i.e. therefore had at some point already become) “earnings” before they were re-directed to be paid to a 3rd party (the principal trust).
The Court of Session disagreed that it was necessary for there to be a ‘present entitlement’ to payment, and distinguished the UBS case by pointing out that the employees there were held only ever to have become entitled to shares, not money. In the present case, the payment was of money and ‘that brings it within Rule 1, not Rule 2 [of section 18(1)]’. (Although, if the shares in the UBS case were ‘non-money’ earnings they would have fallen within section 19(4), not Rule 2 of section 18(1).)
In the case of money earnings, a ‘payment made’ is sufficient to produce a liability to income tax. Here, ‘the net result is no different from an employee who uses post-tax income to fund a trust for the benefit of his family’ (paragraph 70).
On one view, the court’s analysis would appear to have the result that a payment made unilaterally by an employer for, or in recognition of, an employee’s services will trigger a liability on the part of the employee to income tax (albeit with a primary obligation on the employer to account for that tax under PAYE), notwithstanding that the employee himself receives neither the payment nor either the immediate personal benefit of that payment or the power to benefit from it. This, however, ignores the crucial element that if the employee has requested the employer to redirect payment of his earnings to that 3rd party the payment, when made, does not thereby lose its character as ‘earnings’. Given that, on the basis of the facts found by the majority of the First-Tier Tribunal, it was far from clear that the payments could properly be characterised as ‘earnings’ in the first place, the court took it upon itself to interfere with the decision of the First-Tier Tribunal on the basis that it had misapplied the legal principles (per Edwards v Bairstow  AC 14).
Relevant case law
In Forde & McHugh Ltd v Revenue & Customs Commissioners  STC 1872 (CA) and  1 WLR 810 (UKSC), the UK Supreme Court held that payments by an employer to a trust (in that case, a pension fund) were not ‘earnings’ for National Insurance contributions purposes. That term used in that context looked to what the employee received, not what the employer paid : as the employee had not received the sums, they were not subject to NICs. The Court of Session distinguished that decision on the grounds that :
- it was concerned with National Insurance contributions, not income tax;
- a reason why the Supreme Court rejected HMRC’s arguments in favour of liability arising when the payments were made, to trustees, was that, if correct, it would lead to double taxation (tax on the payment in, and again on the payment out), whereas that was not the case with Glasgow Rangers Football Club as any sums paid out of the sub-trusts would not, in the opinion of the Court of Session, be charged to income tax, but will fall to be treated for tax purposes as capital payments out of a trust, with a liability to income tax only arising on income of the trust funds;
(This of course ignores the application of the disguised remuneration rules in Part 7A ITEPA introduced in 2011 but which would be likely to bring into charge any payment out of the sub-trusts – a point ignored by the court !)
- the view of the court did not deprive the terms ‘emoluments’ or ‘earnings’ of any meaning in the relevant parts of the 1988 and 2003 Acts: the situation is no different from that in which an employee uses post-tax income to fund a trust for the benefit of his family;
- here, the computation of tax is not complicated: when funds are paid to the trust they represent consideration for the employee’s services and are taxable accordingly; and
- no argument was advanced in Forde & McHugh as to whether a payment into a pension or bonus fund might properly be analysed as a payment out of the earner’s salary (as in, for example, Smyth v Stretton (1904) 5 TC 36): such arguments have been raised here and ‘thus, Forde & McHugh is not concerned with the arguments advanced in the present case’ (!)
The court also distinguished the case of Edwards v Roberts  19 TC 618 . In that case, payments had been made to a fund created by the employer at the end of each year to enable shares to be acquired and held pending release to the employee after five years’ service. The Court of Appeal upheld an assessment made in the year of transfer of the shares to the employee, on the value of the shares transferred out of the fund, rather than on the value of the contribution made to the fund in that year. The Court of Session reasoned that, in that case, the employee had no entitlement to anything until the lapse of six years. His right to the shares was contingent and would have been defeated had he left employment in that period. By contrast, in the Rangers case, “the trustees became entitled to funds immediately to hold them as redirected by the employee”.
Heaton v Bell  AC 728 is a case concerned with salary sacrifice : cash payments being sacrificed in favour of the provision of a car which, as it was money’s worth’ remained taxable. The Court commented that, in the present case, the payments were of cash, not ‘money’s worth’ : “consequently, we are of the opinion that the requirement for money’s worth [in order for there to be ‘earnings’] does not preclude the present payments from being treated as emoluments”
One might perhaps question the relevance of other cases cited by the Court in support of the ‘re-direction principle’:
In Brumby v Milner  1 WLR 29, it was held that payments made to employees on the winding-up of an employees’ trust were taxable as earnings, being rewards for services. In that case, however, the employees concerned did in fact receive payments. The fact that such payments were at the discretion of the trustee was no bar to them being ‘from’ the employment. What the Court of Session appears to be asserting by reference to this case is that, the fact that the payments to a 3rd party (the principal trust) were at the discretion of the employer did not mean that they could not, on that ground, rank as earnings.
Smyth v Stretton (supra.) appears to be tenuous authority – given the judge’s, own comment that he was not altogether satisfied with his own decision….he thought it ‘arguable’ !. It concerned payments made to a fund for the benefit of assistant masters at Dulwich College. They had no entitlement to the monies unless and until they left employment and even then only subject to conditions. Nevertheless it was held that the payments fell to be taxable as there had been an agreement with the employee that payments into the fund would be part of the employee’s salary entitlement….although whether the hapless masters had much say in the matter, still less any right to decide to take the cash instead, is far from clear…!
HMRC v Collins  79 TC 524 was concerned with the redirection, by a vendor of shares, of the consideration to a pension scheme for the benefit of the vendor. It was not a re-direction of ‘earnings’.
Sloane Robinson Investment Services Limited v HMRC  UK FTT 451 was a case concerning directors’ bonuses. The First-Tier Tribunal held that the decision of the board to pay such bonuses meant that a liability to income tax arose by virtue of Rule 3 of section 18 of the Income Tax (Earnings and Pensions) Act 2003. In any event the employee/directors concerned did ultimately receive the monies, albeit by way of a structure involving the acquisition of shares in a specially-formed company and the subsequent liquidation of the company.
In Sempra Metals Ltd v Revenue & Customs  STC (SCD) 1062 the Special Commissioners held that bonus payments made to a trust, at the behest of the employee, did not amount to the payment of money or a payment equivalent to cash and were not taxable. When the company made the payments to the trust no transfer of cash or its equivalent was placed unreservedly at the disposal of the employees and that meant there was no payment of emoluments or earnings.
In the opinion of the Court of Session, that decision should not be followed: a payment of earnings had here been made, but had been redirected by the employee to another person.
The Court did at least appear to accept that if an employee’s entitlement to ‘earnings’ in the form of payments from a fund is contingent upon the satisfaction of a condition, such as remaining in employment for a given period, there is no liability to tax until the contingency is satisfied (per Edwards v Roberts  18 TC 618).
All in all, the decision reads as if the court was striving to ‘reach the right answer’. The weaknesses might well afford the taxpayers an opportunity for success on appeal to the Supreme Court which may determine that their approach in the Forde & McHugh case has rather greater merit and would result in greater clarity and consistency.
If the decision of the Court of Session stands, it will give rise to real concerns on the part of those companies that make payments to trusts or other intermediaries being amounts that are earmarked for satisfying individual deferred cash bonuses. Prima facie, it would appear that an immediate liability to income tax will nevertheless arise on the amount so paid, and the employer has a corresponding immediate liability to account for PAYE thereon.
However, it is clear from the reference in paragraph 65, to the payment being ‘in a manner that has been requested, or at least acquiesced in, by the employee’ that if the employee has had no say in the decision of the employer to make such a payment to the trust there will have been no ‘payment of earnings’. In most ‘commercial’ arrangements any payment by the employer, being of an amount ‘earmarked’ as intended to satisfy an obligation to pay a bonus, will be paid to a person, typically an employees’ trust, selected by the employer without reference to the employee. However, there will be instances in which employers have canvassed the wishes of an employee as to whether, for example, an amount earmarked as bonus should be deferred into, say, shares held in a trust. It will be in these cases that a legitimate concern would arise.
National Insurance contributions
At the outset, the judgement states that ‘our decision on the income tax issue will apply equally to NICs’ (paragraph 1). This rather side-steps the reasoning of the Supreme Court in Forde & McHugh. Even if one accepts that the decision in Forde & McHugh should not be applied in relation to a liability to income tax, the judgement of the Court of Session fails to explain why the decision of the Supreme Court, as it applied to National Insurance contributions, should not apply in the Rangers case so as to relieve the employer of liability to National Insurance contributions on the payments made.
Did the employee have power to obtain the funds absolutely?
HMRC had argued in the alternative that because the employee had been appointed a ‘protector’ of the sub-funds, he was in a position unreservedly to dispose of the monies. After examining the role of a ‘protector’, the court concluded that such a person has fiduciary duties in favour of the beneficiaries and cannot exercise his powers so as to make himself a beneficiary. As the trust deeds did not include powers to change the definition of the beneficiaries and the protector had not power to do so. For these and other reasons, this submission by HMRC failed.
Is the decision likely to be overturned on appeal?
Quite possibly, given the failure by the Court of Session to explain clearly why, on the facts:
- the payments made were, at the time of payment, properly to be treated as having become ‘earnings’, notwithstanding that the employee had no entitlement to have the payment made (as was the case in Smyth v Stretton); and
- the employee appears to have had no present entitlement to immediate payment of the sums concerned, or even to have payments made to some other person at his direction.
The Court of Session appears to have taken the view that expressing a preference as to whom any payments of salary or bonus should be made is itself sufficient to cause any payment so made by the employer in recognition of services to become a taxable ‘payment of earnings’ per Rule 1 of section 18 Income Tax (Earnings and Pensions) Act 2003 notwithstanding that the employee neither receives nor has any immediate right or entitlement to benefit from the payment.
While, from the point of view of an ‘ordinary’ taxpayer, one has every sympathy with that approach in the particular circumstances of the Rangers case, there are clearly sound arguments that the approach taken goes further than Parliament intended.
It is understood that the liquidator does intend to fund an appeal to the Supreme Court.
for Scotland v Murray Group Holdings Ltd (and others)  CSIH 77
& McHugh Ltd v Revenue & Customs
Commissioners  STC 1872 (CA)
v Roberts  19 TC 618
v Collins  79 TC 524
Robinson Investment Services Limited v HMRC 
UK FTT 451
Metals Ltd v Revenue & Customs  STC