INTRODUCTION:

On the 9th December 2010, the Government released their Draft Finance Bill 2011. It contained a wide range of measures aimed at stopping executives being rewarded by loans from Trusts - and other arrangements designed to defer or reduce income tax. The Legislation has now received Royal Ascent (July 19th 2011) and is the Finance Act 2011.

The main changes impose an income tax charge on any money, or assets made available from any third party to anyone connected with the employee. Even ermarking of funds within the EFRBS from April 2011 will give rise to a full PAYE tax and NIC charge on the employee.

We are pleased to announce that we have a ontract based solution that allows funds held within EFRBS (or EBTs) to be passed into a personal tax-free arrangement. Even better - we can organise the structure such that loans become available without tax.

Where loans need to be settled prior to April 2012, we have a solution for that too.

FINANCE ACT 2011 NOTES:
On the 9th December 2010, the Government released a "consultation draft" of the legislative proposals, now included in the 2011 Finance Act 2011, dealing with what has become known as "disguised remuneration".

Before considering the implications of the Finance Act 2011 provisions, it is worth noting that the process of early publication of legislative provisions has been well received by the profession. It is fair to say that, whilst many of the draft provisions will not change at all, or be subject only to minor tweaking, there are a couple of areas where the draftsman may have far exceeded the scope of what was intended. Many professionals in the industry have already raised concerns with HMRC.

The consultation draft provisions are highly complex (26 pages of legislation and 112 explanatory notes). Following the last two legislative upheavals that affected employees so radically (the employment related securities provisions in 2003, and the non domicile changes in 2008) we had extended periods of uncertainty whilst the legislative changes were clarified.

The proof of the process will be in the extent to which comment is being considered and accepted or rejected in a transparent and timely manner. The landscape is new to all of us.

HMRC INTENT:
The focus of the Treasury in putting forward these consultation draft provisions is on "employers, directors and employees who use arrangements involving trusts and other vehicles to avoid, reduce, or defer liabilities to income tax on rewards of an employment or to avoid restrictions on pensions tax relief".

In many cases, these third party arrangements allowed an employee to enjoy the full benefit of a sum of money paid, or assets provided, while arguing that, because of the structure of the arrangements, there was no legal right to the money or assets, and hence no charge to income tax.

Legislation now ensures that where a third party makes provision for what is in substance a reward or recognition or loan in connection with the employee's employment, an income tax charge arises on its full value, that will be subject to PAYE and NIC.

The Finance Act 2011 is operative from 6th April 2011, but there are also certain anti-forestalling measures that came into effect on 9th December 2010.

As one would expect from legislation running to 26 pages, the position is far more complex and provisions go further in relation to loans.

HOW ARE EXISTING EFRBS AFFECTED?
For arrangements made prior to 9th December 2010 the draft details change very little, as the tax treatment of benefits already provided are "grandfathered" - i.e in that they will not fall under the new regime.

For example, if an employee has already received a loan on beneficial terms, the Benefit-in-Kind tax charge on the unpaid interest would still apply. The terms of the loan can be amended, and as long as no new money is paid out to the employee, then the loan will continue to fall under the old regime.

Notwithstanding that legislation is being introduced, HMRC (buoyed by recent success in the Grogan and Aberdeen Asset Management cases,) are of the view that certain transactions between trustee and beneficiary - (explicitly the appointment/allocation of funds held within discretionary trusts) are not effective, and have made it clear that it will continue to pursue such cases, through litigation if necessary. Along with most other reputable advisors, this is not a view we share (supported by recent judgements precisely on this point in both the Dextra and Sempra Metals cases).

ANTI-FORESTALLING MEASURES to APRIL 2011:
Although anti-forestalling provisions were introduced from 9th December 2010, these are of limited application - primarily to the payment of a sum of money (including by way of loans) to a relevant person and the making available of readily convertible assets as security for back-to-back loans.

Having said this, if the benefit takes the form of a loan that was made during this period, and it is repaid in full before 6th April 2012, this should not give rise to a liability under the new provisions (the historic rules will instead apply). However, anti-forestalling will also apply to some common benefits, such as the provision of education through the payment of school fees under arrangements entered into by a trustee where this follows a request from the employee beneficiary or a connected person.

On the other hand, the anti-forestalling provisions do not catch the earmarking of funds by the trustee or the transfer to, or use of an asset that is not money by, the beneficiary. In addition, we are exploring strategies that will allow for the extraction of cash under the new proposals without the beneficiary incurring a tax charge.

A tax charge under the proposed anti-forestalling rules will take precedence over any other charging provision; for example, a distribution to the employee beneficiary in cash that would be taxable as earnings under current rules. Interestingly, the "tax point" will be 6 April 2012. We appreciate that the employer is left with a decision to make in respect of remuneration to be delivered between 9th December 2010 and 5th April 2011. There is no doubt that the provisions of the consultation draft make EBTs and EFRBS less attractive to employees than before.

The decision as to whether to proceed with a further round of funding will depend upon the outcomes sought. If deferral of remuneration and tax-free roll-up of investment return are the key objectives, then an appointment/allocation of funds contributed to a trust and investment by the trustee work just as well as before, up to the point that a benefit is provided at the trustee's discretion; if that benefit is in the form of a money's worth payment, employment tax and NIC will be due on the value received. This tax charge applies to all form of cash benefits - including benefits paid on the death of an employee where funds were held within an EBT.

We do have a contract based solution, with HMRC approval, that can be used for the distribution of benefits. With these contracts there will be no income tax charge applied and the beneficiaries will still be able to maintain investment control and tax-free roll-up.

For existing EBT and EFRBS there is an opportunity to move funds into these contract based solutions and eliminate the risk of an income tax charge being applied. There is even the opportunity to take loans without triggering a tax charge.

EMPLOYER FUNDING - POST APRIL 2011:
The earmarking of funds "however informally" by a third party will give rise to an immediate tax liability, even if vesting conditions apply and an employee does not acquire legal rights. In consequence, the use of trusts by employers to deliver remuneration will cease.

From the perspective of a beneficiary, the tax and NIC treatment of benefits becomes far more stringent. In simple terms, tax will be applied on the value of the payment (loan funds or value of asset etc) as if an outright payment from the employer had been made.

However, until such time as a benefit is provided, trusts will continue to offer tax deferral and should afford tax-free roll-up of investment return.

The Legislation ensures that where a third party makes provision for what is in substance a reward or recognition, or a loan, in connection with the employee's current, former, or future employment, an income tax charge arises. In short there will be a tax charge, if the third party takes a relevant step to a relevant person, involving any of the following:

A) The payment of a sum of money to a relevant person (including payment by way of loan)
B) The transfer of an asset to a relevant person
C) The provision of money or an asset to secure a loan to a relevant person
D) The provision of the use on an asset to a relevant person

The tax charge will be based on the sum of money received or the higher of cost and market value of the asset provided. There is no provision allowing for relief in respect of this charge in the event of a subsequent non receipt or forfeiture by the employee. A further comment on who is a "relevant person" is merited.

The scope of recipients who could, as a result of a relevant step, give rise to a potential tax charge is much greater than that under current rules, since it includes any person connected with the employee or ex-employee and any other person if the third party takes the step on the employee's behalf or at the employee's direction or request.

As noted above, we are exploring strategies that will facilitate the extraction of cash without a beneficiary incurring a tax charge on his or her receipt.

Finally, it should be noted that there is no time limitation on the application of the employment tax and NIC liabilities that may arise under Finance Act 2011. As a result, the provisions as put forward would endure beyond the death of the employee.

PAYMENT OF THE TAX DUE:
The tax charges arising under the draft consultation rules will be on earnings, and subject to PAYE; NIC will fall due on the same amounts. The obligation to apply PAYE will fall on the employer in the first instance, which clearly creates the potential for failure having regard to the potential for a liability to arise many years hence, but the employer is released from this obligation where the third party accounts for PAYE instead.

Most trusts we are involved with have a provision requiring the trustee to account for the amount due under PAYE out of trust assets, but we may see a shift towards trustees assuming responsibility for paying over tax deducted under PAYE directly.

There is a clear potential for PAYE failure as a result of these proposals. Further, as the trustee is an intermediary, the making good provisions (whereby an employee or former employee will be deemed to be in receipt of income equal to the amount of PAYE not made good within 90 days of the PAYE liability arising) are in point, which leverages the consequences of getting it wrong. We advocate that employers and trustees take steps now to mitigate the risk of future exposure to PAYE failure.

EXCLUSIONS:
The Finance Act 2011 contains a number of exclusions, for example in connection with approved share schemes, registered pension schemes and widely available flexible benefits arrangements.

There are also provisions excluding ordinary commercial transactions from charge. It is worth further considering the exclusion specific to loans on commercial terms set out in the draft consultation legislation. This provision refers to an existing rule in the ITEPA benefits code that was designed to exclude loans made on commercial terms from the definition of employment-related loan. However, it only applies to loans offered by lenders acting in the course or furtherance of their business that an employee takes up on the same terms as offered to the public (eg, a bank employee taking out a mortgage product).

If this is what is intended, it will not matter that a loan to an employee or ex-employee (or other relevant person) extended by the trustee or through a back-to-back arrangement is on a commercial, arm's length basis as the employment tax charge and NIC liability will still fall due on the amount of the loan.

HOW ARE EMPLOYERS AFFECTED?
Employers will be affected by the extended obligation to operate PAYE and liability for NIC (although this may be only an operational burden rather than an additional financial liability in many cases). In relation to the computation of the employer's taxable profit, the amendments put forward make a relevant step giving rise to a tax charge a qualifying benefit for the purpose of the employee benefit contribution legislation dealing with the timing of deduction in computing taxable profits.

WHAT NOW?
We can see a growth in personal planning arrangements such as the contracts offered under Recognised Offshore Pensions (ROPs) legislation. The proposals do not affect these in any way.

With careful planning, a ROPs can hold shares in the employer company and receive dividend payments free from any income tax or NIC charges. Once within the ROPs, funds can be invested within a tax-free roll-up environment. It is even possible for loans of 25% of the funds to be made, again without a tax charge arising.

Another area we can see expanding is the use of Entrepreneur's Relief. We have access to a source that can allow business owners to sell personally held shares. The tax charge being only 10% on the first £5m. Day-to-day control of the business carries on as normal, and after a period of 2 years, there is the option to re-acquire shares and carry on as before.

A combination of ROPs and Entrepreneur's Relief can result in a secure way forward for Directors. added to this there are corporate investments available which reduce effective rates of Corporation Tax - freeing up funds to be paid by Dividend into the ROPs.

We do have access to a number of planning arrangements and investments that allow access to funds locked into EFRBS and EBTs - without triggering a PAYE tax charge.

If you want to know more, simply Contact Us Now.