Here I set out HM Revenue & Customs (HMRC) current view on the Inheritance Tax position in relation to contributions to an Employee Benefit Trust (EBT).
Although the same principles apply where an individual makes a contribution to an Employee Benefit Trust the main thrust here is aimed at the more common situation where the contribution is made by a close company as defined in s102(1).
All statutory references are to Inheritance Tax Act 1984 (IHTA) unless otherwise stated.
Employee Benefit Trust within S86
I assume the Employee Benefit Trust satisfies the provisions of s86 that is, essentially the trust is one where the funds are held at the trustees’ discretion to be applied for the benefit of 'all or most of the persons employed by or holding office with the body concerned' (s86(3)(a)).
Impact of S13 on whether the contribution is a transfer of value
The effect of s13 is that an Inheritance Tax charge arises under s94 on contributions to an Employee Benefit Trust made by a close company where:
- the contribution is to an Employee Benefit Trust which satisfies s86
- the participators (as defined in s102(1)) in that company and any person connected with them are not excluded from benefit under the terms of the Employee Benefit Trust (so that s13(2) disapplies s13(1)) and
- the contributions are not allowable in computing the company’s profits for Corporation Tax purposes (s12) and/or it is not shown for the purposes of s10 that the contributions are made in arms-length transactions not intended to confer a gratuitous benefit.
Participators excluded from benefit
Where the trust deed specifically purports to exclude the participators from benefit but nevertheless the participators do benefit in fact for example:
- by payment to them of loans or
- by assigning funds from the Employee Benefit Trust on sub-trusts for their benefit and that of their family
then HMRC take the view that s13(2) disapplies s13(1) and the Inheritance Tax charge under s94 arises because the funds have been applied for the benefit of the participators.
Impact of MacDonald (HMIT) v Dextra ('Dextra')
This decision applies to contributions made before 27 November 2002.
In a unanimous verdict, the House of Lords upheld the decision of the Court of Appeal in favour of the Inland Revenue in the case of Macdonald (HMIT) v Dextra Accessories Ltd & Others.
What were the facts?
Dextra Accessories Ltd and five other group companies made contributions to an Employee Benefit Trust (EBT), set up by the holding company of the group. They deducted these contributions in computing their taxable profits for the accounting period in which the contributions were made.
The trust deed gave the trustee wide discretion to pay money and other benefits to beneficiaries and a power to lend them money. The potential beneficiaries of the trust included past, present and future employees and officers of the participating companies in the Dextra group, and their close relatives and dependants.
The trustee did not make payments of emoluments out of the funds in the EBT during the periods concerned, instead the trustee made loans to various individuals who were beneficiaries under the terms of the EBT.
What was the point at issue?
The question was whether the companies’ contributions to the EBT were “potential emoluments” within the meaning of section 43(11)(a) Finance Act 1989, being amounts “held by an intermediary, with a view to their becoming relevant emoluments”.
What was the decision?
The House of Lords held that the contributions by the companies to the EBT were potential emoluments within section 43(11)(a) as there was a "realistic possibility" that the trustee would use the trust funds to pay emoluments. The Court of Appeal, agreeing with the High Court, had said that it was "rightly accepted" that the trustee was an intermediary. “With a view to” did not mean the sole purpose (as the Special Commissioners had held) or the principal or dominant purpose (as the High Court had held).
This meant that the companies’ deductions were restricted.
The companies could only have a deduction up to the amount of emoluments paid by the trustee within nine months of the end of the period of account for which the deduction would otherwise be due. Relief for the amount disallowed will be given in later periods of account in which emoluments are paid.
Is the case of wider interest?
The case is of wider importance as contributions to EBTs have been a feature of a number of marketed tax avoidance schemes. The treatment set out below sets out the HMRC view of when relief is available, in light of this decision, for contributions to EBTs before the introduction of Schedule 24 Finance Act 2003.
What EBTs will be affected?
The decision applies to all EBTs where there is a "realistic possibility" under the terms of the trust deed that funds will be used to pay emoluments, however wide the discretion given to the trustees.
It does not apply to contributions made on or after 27/11/2002, which would otherwise be deductible for periods ending on or after that date. Relief for these is governed by Schedule 24 Finance Act 2003.
What are emoluments?
HMRC accept that the term "emoluments" for the purposes of section 43 is wider than just taxable emoluments. It includes money and other benefits convertible into money, even if there is no tax charge at that time the payments are made by the trustees, for example as a result of a statutory exemption.
A loan to a beneficiary is not an emolument. It is simply an investment made by the EBT. At some point the loan will have to be repaid and the money will then be available to the trustee to disburse in line with the terms of the trust (which is likely to be in the form of emoluments).
Will this cause anomalies?
In his judgement Lord Hoffman accepted that this interpretation could lead to some employers never obtaining relief. He went on to agree with the comments of Jonathan Parker LJ in the Court of Appeal, saying that "it is the result of an arrangement into which the taxpayers have chosen to enter."
What will HMRC be doing?
The Anti-Avoidance Group has set up a team to project manage these other cases to ensure that the tax outstanding is collected systematically and consistently.
In appropriate cases, HMRC will be issuing closure notices in cases under enquiry, disallowing contributions where emoluments have not been paid.
Updated Guidance:
HMRC will be reviewing the guidance in the Business Income Manual on EBTs and other areas affected by section 43 Finance Act 1989. Where appropriate, the guidance will be updated to reflect the decision in this case.
Implications for Inheritance Tax (IHT)
Where the company making the contributions to an EBT is a close company, the outcome of this litigation is likely to have implications for IHT.
The effect of section 13 Inheritance Tax Act 1984 (IHTA) is that an IHT charge under section 94 IHTA on transfers of capital by a close company will arise where:
a close company transfers capital to an EBT which satisfies s86IHTA;
- the participators in that company are not excluded from benefit under the EBT, and
- the contributions are not allowable in terms of section 12 IHTA in computing its profits for CT purposes.
In these circumstances the transfers of capital by the company will be transfers of value for IHT purposes.
In terms of section 94 IHTA, HMRC then look through the close company and apportion the transfer of value between the participators "according to their respective rights and interests in the company immediately before the transfer".
Any IHT charge therefore falls on the participators as individuals and will be at the current lifetime tax rate of 20% rising to 40% in the event that the participator dies within 3 years of the transfer (section 7 IHTA).
In that case, the trust deed gave the trustee wide discretion to pay money and other benefits to beneficiaries and power to lend them money. The potential beneficiaries of the trust included past present and future employees and officers of the participating companies in the Dextra group and their close relatives and dependants. The trustee did not make payments of emoluments out of the funds in the Employee Benefit Trust during the periods concerned, instead the trustee made loans to various individuals who were beneficiaries under the terms of the Employee Benefit Trust.
The point at issue was whether the company's contributions to the Employee Benefit Trust were 'potential emoluments' within the meaning of s43(11)(a) FA1989 being amounts 'held by an intermediary with a view to their becoming relevant emoluments'.
The House of Lords held that the contributions by the company to the Employee Benefit Trust were potential emoluments as there was a 'realistic possibility' that the trustee would use the trust funds to pay emoluments. This meant that the company's deductions were restricted. The company could only have a deduction for the amount of emoluments paid by the trustee within nine months of the end of the period of account for which the deduction would otherwise be due. Instead relief for the amount disallowed would be given in the period of accounting in which emoluments were paid.
Sch 24 FA 2003
This statute applies to contributions made after 27 November 2002.
S143 and Schedule 24 Finance Act 2003 prevents a deduction for Corporation Tax purposes until the contribution made for employee benefits is spent by a payment that has been subjected to both PAYE and National Insurance contributions. Thus the position already established in Dextra is therefore effectively formalised by legislation for events on or after 27 November 2002.
Dispositions allowable in computing profits for Corporation Tax purposes - S12
HMRC take the view that there is nothing in s12 that enables its relieving effect to be given provisionally while waiting to see whether the contribution will become allowable for Corporation Tax purposes.
A deduction in the Corporation Tax accounts can be permanently disallowed by the following:
- capital expenditure disallowed by s74(1)(f)ICTA1988.
- expenditure not wholly and exclusively incurred by s74(1)(a)ICTA
Also the timing of a deduction can be deferred to a later period by the following:
- generally accepted accounting practice (UITF13 and UITF32) which capitalises Employee Benefit Trust contributions by showing them as an asset on the company's balance sheet until and to the extent that the assets transferred to the intermediary vest unconditionally in identified beneficiaries
- expenditure subject to s43 FA89 that is, the Dextra decision - see above
- and post 27 November 2002 expenditure subject to Sch 24 FA 2003 - see above
It is HMRC’s view that if expenditure is not allowable for any of these reasons then relief under s12 is not available. The effect of this for Inheritance Tax purposes is that the contribution to the Employee Benefit Trust is a chargeable transfer under s94, assuming that participators are not excluded from benefit (s.13(2))
Relief from the Inheritance Tax charge is only available under s12(1)IHTA to the extent that a deduction is allowable to the company for the tax year in which the contribution is made.
IHT provisions on due date for tax and interest
Where, on HMRC’s view of the matter, a charge to Inheritance Tax arises under s.94, any tax payable is due six months after the end of the month in which the contribution is made or at the end of April in the year following a contribution made between 6 April and 30 September inclusive. Interest is charged on any unpaid tax from the due date.
Does s10 IHTA provide protection from the Inheritance Tax charge?
The s10 test is a stringent one and in the view of HMRC it must be shown inter alia that there was no intent to confer any gratuitous benefit on any person. The possibility of the slightest benefit suffices to infringe the requirement.
HMRC note that
- by its very nature an Employee Benefit Trust is a discretionary trust
- to satisfy the conditions of s86 the trustees' absolute discretion must remain unfettered
- the potential 'beneficiaries' normally include the participators themselves, former employees and the wives husbands widows widowers and children and step children under the age of 18 of such employees and former employees
- contributions to an Employee Benefit Trust will often confer a gratuitous benefit on the participators
In these circumstances, HMRC think it will normally be difficult to show that s10 is satisfied at the date the contributions were made to the trust. HMRC take the view that it is the possibility of gratuitous intent at the date the contribution is made that we have to consider.
Charge on participators under S94
Where a disposition is not prevented by s13 from being a transfer of value, a charge arises under s94 and the transfer of value is apportioned between the individual participators according to their respective rights and interest in the company immediately before the contribution to the Employee Benefit Trust giving rise to the transfer of value.
Summary
This sets out HMRC’s current view. Pending the resolution of any legal challenge to this view, existing cases will be pursued by HMRC on this basis.
