Reversal of fortune: Employee Benefit Trusts and the Rangers case

Rangers Football Club - ATGImages /
Donald Drysdale By Donald Drysdale for ICAS

12 November 2015

The aftermath of the Court of Session’s decision in the Rangers case could be messy for some employers, explains Donald Drysdale.

Victory at last for HMRC

Not much more than a year ago, ICAS was reporting on ‘the Rangers case’ in which HMRC had been defeated at the First-tier and Upper Tax Tribunals.  That had put the tax authority in a tight corner, but the position has now been reversed at the Court of Session in Edinburgh in a case that has attracted widespread attention across the UK.

HMRC v Murray Group Holdings and others [2015] CSIH 77 concerned an employee benefit trust (EBT) for the benefit of employees of a number of group companies, including Rangers Football Club.  A management services company in the group had established a principal trust which had then been used as the basis of a scheme involving a large number of sub-trusts for the benefit of the families of employees of certain group companies.  An employee could obtain a loan from his sub-trust which, it was alleged, would provide him with a tax-free sum greater than a payment of salary net of tax deducted under PAYE.

By a majority decision, the First-tier Tribunal had found in favour of the taxpayers, holding that loans made to a number of employees (before certain changes in the Finance Act 2011 took effect) were genuine loans and not assessable emoluments. Subsequently the Upper Tribunal had upheld this ruling.

On appeal, three judges sitting in the Court of Session have now found unanimously in HMRC’s favour, holding that the funds were ultimately derived as consideration for the employees’ services and on that basis were properly to be considered emoluments or earnings.

Why the concern about EBTs?

EBTs have a respectable role in remuneration strategies.  An EBT may be set up to provide benefits to employees and their families as a means of attracting and retaining staff.  The EBT may hold shares in the company which sets it up, and where the company is unquoted this can be used to create a market in the company's shares for the purposes of employee share schemes.

Many large employers had been seeking to reward employees without operating PAYE/NICs. This was done by making payments through EBTs or other intermediaries that favoured the employees or their families.  The more aggressive arrangements usually sought to secure a tax deduction for the paying company, as if the amounts were earnings of the employees at the time they were allocated, while also deferring PAYE and NICs liabilities or avoiding them altogether.

HMRC took the view that, at the time the funds were allocated to the employees or their beneficiaries, those funds became earnings on which PAYE and NICs were due and should have been accounted for by the employer.  Additionally, HMRC considered that in certain circumstances the arrangements could trigger an inheritance tax charge on the participators in a close company.

Rationale for the decision

In the Rangers case, the Upper Tribunal had ruled on the apparently simple principle that, in law and in fact, earnings from employment can be distinguished from loans made to employees.  The tax legislation provides specific tax treatment for each so, if the form of the arrangement was a genuine loan, the tax consequences for a loan should apply.  There was no need to apply substance over form.

The Court of Session considered HMRC’s alternative contentions: first, that the cash payment to the EBT was part of the remuneration package of the employee;  and second, that the employee could exercise his power under his sub-trust to have the funds paid to him so that, on the ‘Ramsay principle’, the funds were treated as being at his absolute disposal and therefore part of his emoluments.

The judges relied on existing case law supporting the argument that income derived from the personal exertions of a taxpayer comprise income for tax purposes, even if it is paid to a third party. They said that this accorded with common sense, and for this reason they regarded the trust and loan arrangements as ultimately irrelevant.  On this basis they upheld HMRC’s submission that the scheme involving payments to the various trusts and the application of the monies so paid amounted to a mere re-direction of earnings, which did not remove the employees’ liability to income tax.

As the judgment delivered by Lord Drummond Young sets out in detail, the Court of Session determined the appeal on the basis that HMRC’s first contention succeeded, HMRC’s alternative contention failed, but this didn’t affect the end result.

What happens next?

Some commentators have already criticised the Court of Session decision, and it remains to be seen whether the taxpayers will seek leave to appeal to the Supreme Court. As the Court reversed the two earlier decisions and the sums involved are substantial, this seems likely.

HMRC have long maintained that loans made through EBTs should be taxed as emoluments. Back in 2011 the government responded to what they saw as aggressive EBT remuneration arrangements by changing the legislation so that ‘disguised remuneration’ by means of such loans would be taxed as earnings.  At the same time HMRC introduced an EBT settlement opportunity for those wishing to settle pre-existing disputes without recourse to litigation.

This latest judgment is likely to affect only unresolved disputes dating from before the Finance Act 2011 changes took effect.  The settlement opportunity that had existed for these has long since closed. HMRC may be expected to move swiftly to use the Court of Session decision to their advantage, and are already reportedly preparing to issue follower notices and seek accelerated payments of tax in those cases that still remain open.

Article supplied by Taxing Words Ltd

Image credit: ATGImages /


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