New clampdown on employee benefit trusts (EBTs) – contractors beware

George Osborne announced in his 2016 Budget that he intends to address the issue of outstanding employee benefit trusts (EBTs) to recoup what the government considers to be considerable taxes due.

EBTs have been widely used in the past for tax planning purposes. Certain tax planning strategies enabled companies to minimise the tax payable by their directors and employees on their earnings. This worked by the company making tax deductible contributions to an EBT set up for the purpose, following which the EBT would make loans to certain employees. These loans were taxable on the employees as benefits in kind rather than being chargeable to the full rates of PAYE, as would have been the case if they had been paid as earnings.

HMRC first attacked this position back in 2003 by denying corporation tax relief to companies making contributions to EBTs, until the funds were used by the EBT to make payments of taxable earnings. But this left loopholes which continued to be exploited and HMRC continued to find that EBTs, although legitimately used by many companies, increasingly continued to be used to avoid income tax and national insurance.

As a result, the Disguised Remuneration legislation was introduced in 2011. This is extremely complicated legislation which attempts to block any perceived loopholes by broadly saying that any value put into any structure by an employer, which then comes out of that structure to the company’s employees, in whatever form, is taxable as earnings.

The government expected this legislation to bring an end to EBT structures of this kind, and that it would lead to all existing structures being unwound. To this end HMRC offered a favourable settlement opportunity which closed in March 2015. However, many companies did not take up this opportunity, and many structures remain in place which have received tax reliefs which HMRC do not believe are due.

In March 2016 the government announced their intention to introduce new legislation in 2017 which will ensure EBT funds will be taxed to PAYE either when the funds entered the EBT, or when they left or leave the EBT. In the meantime, HMRC are providing a settlement opportunity to encourage companies to wind up existing structures and pay the taxes due under favourable terms, before they are forced to do so.

Time limited settlement opportunity

If a company agrees with HMRC to pay PAYE based on all contributions made to an EBT, HMRC will accept there is no further charge when the funds exit the EBT; typically, when the EBT is wound up under an enquiry agreement with HMRC. To encourage companies to settle their EBT cases, this credit agreement will only be available if the tax is paid by 30 November 2016. If not, there will be a PAYE charge on the investment element when the funds exit the EBT.

For example, if contributions of £100,000 were made to an EBT, and these have subsequently grown to £150,000, when the company settles its liabilities relating to the EBT, it can agree to pay PAYE based on the original contribution of £100,000. When the EBT is unwound and the funds of £150,000 are distributed to the company’s employees, the growth in value of £50,000 will not be subjected to PAYE provided the settlement has been agreed and paid by 30 November 2016. (Note however that the growth in value may be taxable in whole or in part under other provisions). If the settlement is however agreed and paid at a later date, the additional £50,000 will be subjected to PAYE.

Expanded legislation

The measures which are to be introduced in 2017 will alter the landscape for EBTs. The legislation is subject to consultation, and there is a very remote chance that it may not be enacted. However, based on previous initiatives, it can be expected to come into force. Under this new legislation it is proposed that any loans to employees which remain outstanding on 5 April 2019 will be subject to a PAYE charge on that date on the full value of the loan, regardless of when it was taken out. It will also be possible for HMRC to collect the PAYE on this liability from the employee rather than the company. This is expected to largely impact contractors who have been using such schemes for a period of time.

Next steps

Although these proposals are still under consultation, anyone with an EBT should be prepared to make tax payments and settle outstanding amounts.

Assuming this legislation will go through, companies with existing EBTs, and the employees who have received loans from them have very few choices;

1. They can repay the loan(s) before 5 April 2019 and avoid a tax charge – however this is unlikely to be practicable;

2. They can keep the loan(s) and trigger the PAYE charge on 5 April 2019, exposing the employee to a personal liability;

3. They can wind the EBT up before 5 April 2019 and trigger a PAYE liability on the winding up; or

4. They can seek a settlement with HMRC before 30 November 2016, and wind the EBT up as part of that settlement.

We recommend that anyone wishing to take advantage of the settlement opportunity available should seek expert advice before approaching HMRC.

For more information, please contact Anne Eager by emailing ae@rjp.co.uk.