HMRC has started an initiative to settle outstanding EFRBS cases, by issuing an EFRBS Settlement Offer under the Litigation and Settlement Strategy. Further details of the offer can be found on HMRC’s website, here. Your clients may well have received an offer letter from HMRC, and the obvious question is whether to settle. HMRC’s letter requires an expression of interest by 31 December and for the settlement to be completed by 30 June 2014, so the timescale for making a decision is very short. That said, we do not believe that an expression of interest is binding on your clients. So if they decide not to settle as the discussions with HMRC proceed, they can withdraw from the initiative.
There are two alternative offers: one is to settle on the basis that no CT deduction is due, so that the CT is paid on the contribution and the professional fees; the other is to pay the income tax and NICs in respect of the contributions to the EFRBS, in which case a full CT deduction is given for the contributions to the EFRBS and for the professional fees. Both have their advantages and disadvantages.
Settlement for CT only
The first version is not at all generous, as, in effect, HMRC want you to revert to the way they see the legislation, so that the CT deduction is not due until someone pays income tax and NICs on the amounts contributed. This means that HMRC will not then press for the income tax and NICs until amounts are formally paid out of the trusts to the beneficiaries. HMRC also say that they will disallow the deduction for professional fees incurred in setting up the EFRBS. But we cannot see that this is justified under the normal corporation tax rules, as setting up an EFRBS is a business expense incurred wholly and exclusively for the purposes of the trade, and the legislation does not specifically disallow these costs, only the contributions.
If your clients are keen to settle, this is arguably a low-cost option, as the CT is a smaller amount than income tax and NICs. On the other hand, it still leaves the trust in place and the trustees will need to operate PAYE / NICs as and when any payments are made out of the trust to employees or former employees. That said, it might be possible for sums to be paid out of the trusts in future with lower tax charges. For example, if the fund were to be used to pay pensions to the employees or directors when they retire, the rates of income tax may be lower or the pensioners might have retired abroad, so that there is no PAYE or NICs charge in the UK (the pensioner would, of course, have to consider whether there are any tax charges in their country or territory of residence).
Income tax and NICs settlement
This offer is on the basis of treating the contributions to the EFRBS as being earnings, subject to PAYE and NICs at the time the contributions were made. The contributions, the income tax and NICs and the professional fees, would all then be deductible for CT purposes (there is no CT deduction for interest paid on settlement). The settlement of income tax and NICs would inevitably involve larger numbers than a settlement for CT only but the idea is to clear the whole thing up and allow you to unwind the trusts by distributing the trust funds to beneficiaries post-settlement free of any further tax (save for any tax on overseas income in offshore EFRBS).
Our concern with this approach is that HMRC has had numerous attempts at persuading the Courts that contributions to EBTs should be taxed as earnings, and the Courts have rejected the argument every time. So it seems likely that HMRC would be reluctant to litigate on this basis and would prefer to litigate cases on the basis of refusing the CT deduction, instead.
On the other hand, although such a settlement might lack a statutory basis, it can provide finality and closure for all concerned, which might be something your clients want.
If the company pays the income tax and NICs, these should be repaid to the company by the trustees or the employees (the exact requirements will depend on the wording of the trust Deed). Otherwise, the income tax and NICs are treated as additional ‘earnings’ of the employee, so that more tax and NICs would be due. We understand that HMRC has been quite helpful in this area, when considering settling EBT cases.
There are a number of entirely legitimate uses of the funds in an EBT that do not or may not carry a charge to tax or, a lower ‘effective rate’ of tax. As mentioned, paying out pensions might be an efficient way of using the funds, either through lower tax rates in the future or because the individuals concerned are no longer UK resident. Other thoughts include selling assets to the trust, licensing assets through the trust, etc. We would be happy to discuss these in more depth, if they might be of interest to your clients.
While neither route to settlement is entirely satisfactory, both have their potential upsides, including getting HMRC to go away. That said, if your clients are comfortable with their current position, they could arguably be no worse off settling later, with the only downside being a greater charge to interest. However, there could be an increased risk of incurring tax charges on additional earnings if the trustees do not reimburse the company for any income tax and NICs which are subsequently held to be due on the contributions and which are paid outside the EFRBS Settlement Initiative.
To a very large extent, it comes down to how your clients feel, whether they want closure or partial closure, whether they are prepared to wait and see, and so on. While HMRC suggest that they will litigate every case that doesn’t offer to settle, we don’t believe that they can litigate every single case, so they will have to use the lead case procedure, which may allow others to adopt a wait-and-see approach.