Why most EBTs haven’t had to pay HMRC – yet

With headlines like ‘HMRC’s haul from EBT users seems shy of £2bn,’ contractors would be forgiven for thinking that the taxman isn’t doing his job when it comes to Employee Benefits Trusts – just at a time when his other efforts to claw back much-needed revenue appear to be increasing, writes Gerry Brown, manager of tax and trusts at Prudential.

Before I explore what is widely perceived to be the currently low yield from the Revenue’s clampdown on EBTs, and consider the implications for one-person companies who used them, some background is necessary.

What is an EBT?

There is no statutory definition of an EBT. HM Revenue & Customs adopts the approach that any trust which provides ‘benefits’ (in the widest sense of that word) to current (and former) employees could be an EBT. Retirement benefits schemes (- basically pensions) and approved share schemes are excluded.

How EBTs avoided tax

The planning idea behind EBTs is deceptively simple. An employee wishes to postpone tax (perhaps indefinitely) on his /her “reward”, to use a neutral term, from an employer. Instead of paying the employee a salary, the employer makes a payment to a trust of which the employee is a beneficiary. The trustees make loans to the employee possibly interest-free. There may be a benefit-in-kind charge but the tax bill is modest when compared to the tax and national insurance liabilities on a salary of an equivalent amount.

When HMRC blocked EBTs

There are many variations on this basic theme. HMRC moved to block this type of scheme with various anti-avoidance provisions. The effectiveness of some of these provisions is a matter of debate. However much tougher provisions, known as the “disguised remuneration” rules, are widely believed to have stopped the establishment of most types of EBT. These disguised remuneration rules were effective from April 6^th 2011, and indeed they could have been triggered by actions before that date.

But what of those EBTs set up before 6 April 2011? HMRC believed that the “old” anti-avoidance legislation “worked” and has litigated against many arrangements with a considerable degree of success.

In an effort to avoid costly litigation, the Employee Benefit Trust Settlement Opportunity (EBTSO) was launched in April 2011. Users of EBTs had to disclose arrangements by December 31^st 2011.

HMRC’s ‘low’ yield from EBTs

Since then, £650 million in “additional” tax has been collected from EBT users and HMRC estimates a further £300 million will be collected from EBT cases under review, the Times has reported.

The general approach being taken is to tax the “payments” (mainly sums advanced by way of loan) from the trustees to the employees as remuneration with the employer picking up the tax and NIC bill. The amounts so paid will be tax deductible in the employer’s tax computation making this a relatively attractive option for the employer. Other approaches are possible; HMRC is keen to settle cases.

But as alluded to the outset of this article, it was originally estimated by HMRC that its ‘take’ from EBTs would be of the order of £3billion. And to reiterate, so far only £650m has come in to the taxman.

So, why the apparent shortfall? I believe there are many reasons:

• There is a tendency, not confined to HMRC, to overestimate the beneficial impact of any course of action. The positives are accentuated; the negatives downplayed. This psychological trait is present in us all. Could the HMRC estimate of recoverable tax have been too high? There is no public record of the methodology behind the calculation of the expected tax yield.

• Rangers’ victory at the First-tier Tribunal [Murray Group Holdings and Others v HMRC] has encouraged some EBT users to litigate rather than settle. And the HMRC appeal to the Upper Tribunal is unlikely to be heard until mid-2014! The Supreme Court is due to hear an appeal in a case on the national insurance contributions liabilities of EBT users [HMRC v Forde & McHugh Ltd] in January 2014. There is still uncertainty as to the correct application of the tax legislation in particular situations. Decisions such as that in the Rangers’ case encourage the desire to litigate rather than settle.

• The time taken to “discover” and settle cases has probably been significantly underestimated. In August last year, 8 months after the disclosure deadline, HMRC issued 41 pages of “frequently asked questions”. The first question covered employers who had not responded to the EBTSO by December 31^st 2011. The answer was “come and talk to us”. Other questions covered situations where employers had EBTs that were not under enquiry with HMRC – again, the answer was “obtain certainty” and settle.

• In ‘conventional’ tax investigations, interest and penalties are levied on undisclosed income or gains. The penalty can often be reduced where the liabilities are quantified and agreed quickly. In most cases where EBTSO is used, tax liabilities for earlier years will suffer an interest charge until payment, but no penalty. This is unlikely to hasten early settlement.

• In settling cases, HMRC is inviting employers to make “voluntary restitution” in respect of time-barred liabilities. This often requires the consent of shareholders and/or offshore trustees and such consent might not be readily forthcoming.

• There must be some EBT users who remain blissfully unaware of the tax storm raging around them.

Slow progress in the winnable war against EBTs

Overall, then, and based on the HMRC internal estimate figures cited above, progress has been slow. Yet HMRC has the resources, even in these straightened times, to pursue cases to the bitter end. Whatever the time taken, HMRC will probably eventually collect most of the tax due, whether through litigation or through EBTSO. Yes, some cases will slip through the net undetected. So ultimately, HMRC will lose a few battles but win the war.

However, HMRC has claimed to ContractorUK that the department is “pleased” at the yield to date. That is debatable. HMRC is probably pleased that the future use of EBTs has probably been stopped, but it can’t be pleased at the time being taken to bring outstanding cases to a conclusion.(Resources are being devoted to tackling the most widely used schemes and those more sophisticated arrangements where significant amounts of tax are at stake.)

One-person companies who used EBTs

As to the one-person company who used an EBT, HMRC will probably get them in the end, so it is potentially best to make use of EBTSO. But professional advice should be taken before a single-person business who used an EBT decides how to proceed. Worryingly for these ‘one man bands,’ the cost of such advice will likely be significant in relation to the tax at stake.

This is because the employer and employee will effectively be one and the same, so fees will be a drain on the enterprise. It would be nice to think that when the schemes are unravelled the small enterprise will be in the same position as if it had operated PAYE on a salary equivalent to the amount paid, indirectly, to the employee. Unfortunately the fees and compliance costs will turn out to have been incurred for no significant economic benefit. So I imagine some affected company owners will be pinning their hopes on themselves or their professional services generating enough additional profit to absorb the costs.