Recent developments for employee benefit trusts

Important developments are taking place in the field of remuneration planning. 

New rules for ‘disguised remuneration’

On 9 December 2010 the government published draft legislation targeting soft loans and other benefits received from employee benefit trusts. From 6 April 2011 employment income tax charges will arise not only when trustees pay cash or benefits to an employee but at any earlier stage when the asset is ‘earmarked’ for the purpose. Further, the new rules can treat something done to an employee’s family as something done to him. Thus the rules do down simple planning such as trustees making payments to the wife of an ex-employee. 

Under anti-forestalling measures, payments of sums of money are already caught by the new rules. However, other asset transfers may still be possible before 6 April. 

UBS AG v HMRC

The FTT released its decision in UBS on 6 August 2010 ([2010] UKFTT 266 (TC).

UBS wished to pay bonuses to its staff without PAYE and NIC. It therefore arranged to pay the bonuses by way of a special class of shares in a newly set up company (the SPV). The shares were forfeitable by the employee at the end of three weeks at a discounted price if the FTSE 100 moved by a certain amount. Subject to that, they could be redeemed for cash at near unrestricted value. The SPV’s articles were drafted so that it was not associated with UBS at certain key times.

The FTSE did not move, and the employees redeemed the shares for cash (in some cases, over two years later).

UBS argued that the shares were ‘restricted securities’ within ITEPA 2003 Part 7, and as such their acquisition was expressly exempted from tax. Further, although there could be a charge when the restriction lifted, because the SPV and UBS were not then associated, the charge was expressly disapplied. No other ITEPA charge applied.

Before the FTT, HMRC’s core argument was that the employees became entitled to their bonuses before they acquired any shares in the SPV. HMRC must have hoped this would be a knockout blow. But the argument failed. There was no evidence of an employee being entitled to a discretionary bonus before the shares were awarded. However, HMRC had a minor victory on guaranteed bonuses.

HMRC also failed to show that the clause in the SPV articles which prevented it being associated with UBS could be ignored as a ‘pretence’ (in the Antoniades v Villiers sense, of being contrary to the whole purpose of the articles). This had to be a difficult argument for HMRC. The SPV and its directors intended the clause to have full effect because they wanted the tax exemption. As the FTT held, it was the very opposite of a ‘pretence’.

However, HMRC won two important arguments. The FTT held that the shares were not ‘restricted securities’ as defined. Thus, there was no exemption on acquisition. Also, that even if the shares were ‘restricted securities’, viewed realistically, what was awarded to the employees for the purposes of ITEPA, was cash not shares. Thus, Part 7 was irrelevant.

These two findings are surprising: some employees kept their shares for over two years. However, the SPV had put in place a hedging arrangement designed to ensure that, whatever happened, the employees would receive the value of their intended bonus. If HMRC win the appeal (and they may not), it will be interesting to see whether it is because of the hedge. If it is, that could be good news for other taxpayers.

Aberdeen Asset Management v HMRC

This case ([2010] UKFTT 524 (TC)) concerns an old PAYE and NIC scheme known as a ‘discounted share scheme’. Broadly, the employee obtained a beneficial interest in shares in what the FTT called a ‘money-box’ company, from which he could apply for soft loans and procure dividends.

The share value was diluted by an option (held by an EBT) to subscribe for shares in the company. The FTT held that PAYE and NIC were due, primarily on the basis that the employee had received a ‘pot of money’ in a ‘money box’ to which he had ‘the key’. The decision was released on 29 October 2010.

This case is a further example of the difficulties facing HMRC in alleging ‘sham’ as an alternative to a Ramsay argument. As in UBS, HMRC tried and failed to show that a key part of the arrangements (here, the option could be ignored as a ‘pretence’. However, this kind of challenge cannot be underestimated: see Prudential v HMRC (CA) [2010] STC 2459, CA, for an HMRC win using a related argument). 

On the other hand, the decision blurs the line between what is a benefit in kind and what is a cash payment.

The FTT found that on receiving shares in the ‘money-box’ company, the cash in the company was placed unreservedly at the employees’ disposal, and the employee could be treated as receiving cash. The views of the appeal court on this issue will be awaited with great interest.

Summary

Having regard to UBS and Aberdeen it seems the current view of the tribunals in applying a BMBF style approach to technical tax planning is that ‘taking a realistic view of the facts’ gives them a lot of flexibility in recharacterising schemes in a way they might not have done before. If the courts continue to take this approach, one has to ask whether we really need the new rules on ‘earmarking’ in ITEPA 2003 Part 7A, particularly when these new rules will catch not just the unacceptable tax avoidance schemes, but all sorts of innocent transactions.