If your deal structures include employee benefit trusts, read on – your investee companies may end up paying a lot more tax than you bargained for under new anti-avoidance rules announced late last year, and which are now in effect.
A PAYE charge will be triggered if any third party (typically an employee benefit trust (EBT), established by an employer):
- "earmarks" any asset or cash for; or
- pays any sum (including by way of loan) to; or
- makes any asset available to...
...any employee or director, or anyone "linked" to them. And this includes former or prospective employees, so you can't get around it by having someone resign, and then re-appoint them later.
Typical schemes caught by the new rules include:
- loans made by EBTs to employees which are never repaid; and
- the creation of so-called "family trusts", under which cash or assets are placed into a sub-trust solely for the benefit of a named employee and his or her family members.
For example, under the new rules if an EBT makes a loan to an employee, a PAYE liability will, in most circumstances, arise on the full amount loaned – at the time the loan is first made (irrespective of whether or not the loan is later repaid). Or, if cash or shares are placed into a trust for the benefit of a named employee and dependents, a PAYE charge can arise on the value of the assets, or the amount of cash, placed into that trust.
And the draft legislation is far-reaching. It will catch some pension arrangements, such as Employer-Financed Retirement Benefit Schemes (EFRBS), as well as other more aggressive tax or NIC-saving schemes that use EBTs. In fact, it is so widely drafted that it could catch arrangements which were never intended to be caught, including some kinds of share schemes, and deferred remuneration arrangements. So far, we've had two sets of FAQs issued by HMRC, but these raise as many questions as they answer.
However, there are exemptions for "approved" share option arrangements, and for registered pension schemes.
What if I just use an EBT to warehouse shares?
The new legislation should not stop EBTs from buying shares off managers in the usual way (e.g. as part of any leaver arrangements), or from warehousing those shares until a buyer is identified. However, income tax charges may arise as and when those shares are transferred out of the EBT, or are "earmarked" for a manager (and for these purposes "earmarking" includes informal non-binding understandings).
What should you do about it?
If you already have a scheme in place for an investee company that uses an EBT and which you think may be caught by the new rules, you need to review it to see whether or not it still works. If it does not work any more, you should consider how best to close it down.
But, bear in mind that if you continue to operate an arrangement which is caught by the new rules, your company will have to operate PAYE on the value of the benefits provided - including employer's national insurance (which cannot be passed back either to the employee or the EBT). So if you do keep a scheme in place, you should check exactly how your investee company will be able to recover the income tax and employee's NICs arising, either from the EBT or the executive. The investee company is "on the hook" to HMRC irrespective of whether or not you can force the executive, or the trustees of the EBT to reimburse the tax and NICs.
If you were thinking about putting into place any kind of scheme using an EBT (whether or not you're doing it to avoid tax), think again. We cannot yet say with certainty precisely what arrangements will end up being affected. The new rules are not yet finalised – the draft legislation is published, but may still be subject to change. And once they have been finalised, we would hope for some more detailed (and definitive) guidance from HMRC on how widely it will apply the new rules.