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Disguised remuneration: HMRC’s FAQs

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The draft legislation on disguised remuneration published on 9 December 2010 raised many questions for employers who operate share incentives through employee benefit trusts, deferred remuneration plans and unapproved pension arrangements. As a result of the consultation process, HMRC has published guidance in the form of Frequently Asked Questions which go some way to allaying fears about share schemes and certain deferred remuneration structures but offer cold comfort for Employer Financed Retirement Benefit Schemes.

The draft disguised remuneration legislation, published on 9 December 2010, will impose an immediate income tax charge from 6 April 2011 where a ‘relevant third person’ takes steps to allocate or earmark cash or assets or make them available by way of loan or distribution

Income tax will be payable through PAYE, together with National Insurance Contributions (NICs) as though the employer had paid employment income of equivalent value to the employee. Anti-forestalling rules cover loans and assets provided between 9 December 2010 and 6 April 2011 to the extent that these remain outstanding as at 6 April 2012.

The legislation as drafted referred to employees and any person connected, linked or associated with them, in respect of whom action is taken by third parties such as trustees of an employee benefit trust (EBT), group companies, partnerships and nominees, thereby catching myriad different arrangements.

HMRC subsequently received over 50 formal responses to the proposed legislation and actively engaged with interested parties during the consultation period, with the result that a number of refinements will now be made. The policy aim continues to be to protect tax revenues, but HMRC recognise that it should ‘limit’ the impact where arrangements are not used for avoidance purposes.

Much of the criticism was directed at:

  • the lack of clarity regarding ‘earmarking’ and the apparent failure to consider the impact on common types of share schemes and deferral arrangements;
  • the wide definition of ‘relevant third person’;
  • the treatment of certain types of loans; and
  • the inclusion of genuine Employer Financed Retirement Benefit Schemes (EFRBS).

The FAQs go some way to mitigating initial fears in some of these areas, but there are other areas in which the rules continue to be unduly tough.

‘Earmarking’ and employee share schemes

As originally drafted, if a third person earmarked cash or assets for the benefit of an employee, with a view to a later step being taken, this would constitute ‘earmarking’ even if the employee never received anything, because performance or service requirements had not been met.

This would accelerate the income tax charge for typical deferred bonus arrangements (such as those now required by the FSA Remuneration Code for financial services companies) and grants of share awards which were to be satisfied by shares allocated in an EBT, while ignoring the commercial rationale for deferring receipt of rewards contingent on performance and employment.

The exclusions were initially limited to HMRC approved share schemes and unapproved option schemes but did not cover long-term incentive plans (LTIPs) in the form of a conditional right to receive shares.
There was also concern that employees who sold shares to a third party at market value would find their sale proceeds taxed as income which would adversely affect growth share or joint ownership plans which are intended to offer capital treatment.

These unfortunate consequences were quickly pointed out to HMRC who responded appropriately by confirming that:

  • deferral arrangements with specific vesting conditions lasting no more than five years will not attract a charge under the new rules, provided that the vesting conditions are such that there is a ‘realistic chance’ that they will not be met, an income tax charge arises on vesting and if the employee fails to meet the vesting conditions, there would be no continuing entitlement (FAQ 1);
  • LTIPs with similar hallmarks requiring vesting over a five-year period will also not be subject to a charge where shares are allocated to satisfy those awards (FAQ 23);
  • shares can be acquired by an EBT, or funds can be paid for this purpose, with the intention that shares are held for future delivery to, as yet unidentified, employees without incurring a tax charge (FAQ 24); and
  • employees who sell shares to a third party at or below market value, for example to an EBT on termination of employment, or under a growth share or joint ownership plan, will receive a credit for the market value of those shares (FAQ 25).

These amendments are undoubtedly helpful, although further clarification would be useful on the meaning of a ‘realistic chance of forfeiture’ in respect of deferral arrangements.

Care may also be needed with leaver provisions for deferred and long-term incentive schemes to ensure that there is no continuing entitlement if performance and/or vesting conditions are not met.

It may be acceptable for rules to allow good leavers to receive a pro-rated award on termination but it is not clear if a company could wait for the full vesting period to terminate before determining the extent to be paid; the ABI Guidelines on Executive Remuneration for listed companies recommend that on cessation of employment, the original performance period should continue to apply unless early vesting is more appropriate.

No specific mention is made of ‘hedging’ arrangements, particularly those associated with phantom share schemes. Employers who operate phantom share schemes often provide funds to an EBT to acquire shares which are notionally allocated to participants, with the shares being sold on vesting to fund the cash payments. It is assumed that provided the underlying awards carry the hallmarks required of long-term incentive schemes, no tax charge will arise when shares are allocated but focused guidance on this point would be welcomed.

‘Relevant third person’

All third parties were originally included in the definition of ‘relevant third person’. HMRC now accept that group companies should not be included in this definition, although there will be an anti-avoidance test (FAQs 3 and 13).

HMRC also confirmed that arrangements made directly between employees and employers should not fall within the definition of ‘trustee’ (FAQ 6).

The effect of these changes is that loans can be made by group companies to employees – for example, to help them acquire shares, without falling within the rules. Employers can also hold money on behalf of a specific employee without being caught.

However, it is not entirely clear whether other bona fide ‘ring-fencing’ arrangements, such as holding sums in an escrow account to be paid out on completion of a transaction, are exempted. There will also be circumstances where, previously, loans were made through an EBT rather than a group company – for example, where company law provisions restrict loans to directors – but in future, a loan through an EBT will be taxable.

Loans and distributions

HMRC clearly intend to tax loans made through EBTs wherever possible and this is where many of the harsher provisions of the draft legislation can be found.

Anti-forestalling applies to loans made between 9 December 2010 and 6 April 2011 such that a tax charge arises on 6 April 2012 unless the loan is repaid before that date (FAQ 30). But loans made after 6 April 2011 will always be subject to an immediate, non-refundable income tax charge even if they are subsequently repaid (FAQ 32). This is particularly penal and will certainly discourage the payment of long-term loans to employees through EBTs.

If sums have been previously allocated to a sub-fund for particular beneficiaries of EBTs or family benefit trusts, but are undistributed, a charge will arise when a distribution takes place or any other relevant steps are taken, even if the sub-fund was established pre-December 2010 (FAQ 31).

A loan paid, or assets distributed from a sub-fund before 9 December 2010, on the other hand, will be outside the legislation (FAQ 29) but HMRC are likely to continue to challenge them– presumably on the grounds of non-payment of PAYE and NICs on the basis of Sempra Metals Ltd v HMRC [2008] STC (SCD) 1062 or IHT as suggested in the article by HMRC (‘HMRC & EBTs’ (Ronnie Macdonald) Tax Journal, dated 19 January 2009).

HMRC are still considering whether there should be an exemption for short-term loans for specific purposes (FAQ 13). While it is not stated what HMRC may have in mind, it is possible that this could cover a cashless exercise facility to acquire shares or season ticket loans.


HMRC maintain that EFRBS have been used to provide loans and avoid tax and the creative use of EFRBS to provide retirement benefits is not in keeping with the intention to create a ‘more affordable’ pensions tax regime.

Some EFRBS are used to provide pension arrangements similar to those that could be paid under a registered scheme. However, no exception is to be made and any contributions will be taxed (FAQ 15). This will make it more difficult for those who exceed the new £50,000 annual allowance for contributions to registered schemes, to find tax-efficient ways of investing long-term remuneration.

Any wholly unfunded arrangement will fall outside the rules. The FAQs suggest that if an unfunded promise is just recorded as an entry on the balance sheet as a liability of the employer or is secured by a letter of credit by a bank, itself secured by a floating charge over the employers’ assets, there will not be a tax charge, but this will depend on the facts (FAQ 17). There may be renewed interest in such unfunded arrangements, if they are commercially acceptable to employees.

If tax has been paid on contributions to an EFRBS, an amendment means there will not be double tax on the receipt of benefits – any tax at that point will be limited to the value of the benefits in excess of the amounts initially charged to tax (FAQ 22).

Transfers between corresponding overseas schemes will only be exempted from a charge to the extent that the transfer value is referable to contributions before 6 April 2006 (FAQ 18). 

Other points

Helpful clarification was also given as follows:

  • where funds are already held in a sub-trust, the accrual of income and gains within that trust will not, of itself, give rise to a charge, although there will be a tax charge under the new rules when distributions are made (FAQ 12);
  • reinvestment of income by trustees at the suggestion of the employee is not taxable (FAQ 33) so trustees can continue to make investments at their discretion in accordance with expressions of wishes by beneficiaries;
  • construction industry holiday pay schemes, which involve sums of money being allocated and paid to employees by third parties will be exempt (FAQ 4);
  • if employees subscribe for shares through a public offer and then receive dividends, such dividend payments should not be caught (FAQ 5); and
  • salary sacrifice for tax-exempt or advantaged benefits should not, of itself, be tax avoidance for the purposes of the exemption for employee benefits packages in new ITEPA 2003 s 554G(4) (FAQ 10). However, HMRC do not rule out the possibility that some salary sacrifice arrangements could fall foul of this.

Overall, HMRC’s guidance is to be welcomed although there are still some questions under consideration and further FAQs are likely in due course. However, the fact that so many responses raised fundamental concerns, suggests that HMRC’s initial policy was poorly thought out and not reflective of market practice.

Karen Cooper Partner, Osborne Clarke.

Natalie Smith, Senior Associate, Osborne Clarke.