August 2019

Many readers will be aware of the close HMRC attention in recent years in respect an Employee Benefit Trust “EBT” which, in broad terms, is a trust established either in the UK or offshore by a limited liability company to hold cash or other assets for the benefit of certain employees. Quite often, the only employees of the company who benefit from an EBT are the directors.

Generally speaking, the purpose of an EBT is to incentivise employees and help retain quality staff by providing a benefit to them. When first conceived, they were not designed to be used ( some might say “abused” ) as they have been over the last 25 years or so. An EBT and the company that creates it, are two separate legal entities which means that once the company has transferred property/cash into the EBT, it is run by trustees who have ultimate control over trust property, although they will often be guided by recommendations from the company. As the trust is a separate legal entity, it will continue to exist even if the company has a change of ownership or is liquidated.

For many years up to the mid 2010s, it was not uncommon for employers to pay bonuses to selected employees by transferring money to an offshore EBT : it is the offshore EBTs that attract HMRC interest. Typically, money is passed to an employee from the trust by way of an interest-free loan which, in practice, remained unpaid indefinitely. Perhaps unsurprisingly, HMRC considered these to be tax avoidance arrangements that sought to avoid income tax and NIC because, if the loan was never repaid, the cash was seen as representing net-of-tax money which, in normal circumstances would have been subject to tax and NIC before being passed to the recipient.

The 2017 Finance Act introduced the concept of a loan charge which applied to all loans made subsequent to 6 April 1999 which had not been repaid before 5 April 2019. The charge is designed to represent the income tax and employee’s NIC which would have been deducted if the monies had been processed through the company’s payroll in the normal manner. Broadly, if £600,000 was placed into an EBT and then lent to an employee, HMRC can contend that income tax and NIC liabilities of at least £550,000 would have been created and paid to HMRC : a significant loss to the Treasury. This helps to explain the large demands which many companies are facing from HMRC as a result of the legal challenge to the validity of an EBT scheme.

Liquidators have the ability to agree a company’s tax liability with HMRC but clearly, if the liquidator advises HMRC that there are assets left with which to pay the claim, one might argue that the liquidator is entitled to pursue the person who received the cash under the principle of unjust enrichment and therefore, seek restitution to the company of the deductions which should have been withheld at the outset.

Directors of some companies which have been unable to repay employee deductions to HMRC have sought to liquidate the company, hoping to avoid HMRC because HMRC tend to pursue the company for the employee deductions. However, where the employee was also a director, legislation allows HMRC to pursue directors personally. Such an approach is becoming increasingly frequent when HMRC discover that the liquidated company has no assets and consider that the directors are to blame.

In short, where a director was involved with an EBT and HMRC are able to demonstrate that the director knew, or ought to have known, that the income tax and employees’ national insurance should have applied, the company status can be ignored, leaving HMRC to pursue the directors and bankrupt them if necessary.

From a liquidator’s viewpoint, one option is to invoke section 212 of the Insolvency Act 1986 to pursue directors on the basis that the directors owe a fiduciary duty to act in the best interests of the company and hence, all stakeholder groups. If participating in an EBT gave rise to a loss to creditors because significant sums were transferred out of the company and creditors are prejudiced, the liquidator can pursue a director’s personal assets.

Further, section 213 of the Insolvency Act 1986 allows a liquidator to argue that paying funds into an EBT was designed to defraud creditors by placing company assets beyond their reach, and that directors should be aware of the duty to ensure that a company pays tax on behalf of itself and its employees. Sometimes HMRC pursue a claim directly against a director, often in conjunction with the liquidator, thereby closing all doors of escape for such director.

When challenging an EBT, the argument is often given that an EBT must have seemed too good to be true in terms of the ability to continue to live and work normally in the UK without paying tax on substantial income earned from UK employment and thus, those who participated have only themselves to blame. The counter to this view is that all those who became involved in an EBT did so on the advice of professional advisors and hence, had every right to believe that what was being entered into was a perfectly valid scheme.

Experience shows in recent years that HMRC have their sights set firmly upon directors of companies who established EBT arrangements. Accordingly, seeking to liquidate the company in the hope that the whole saga will be swept away and forgotten is likely to be a forlorn hope for many directors.

As might be expected, an increasing number of directors are beginning to seek advice regarding their personal financial affairs because when the money was received in their hands through an EBT it was spent rather than invested i.e. there is nothing left to settle any amount that may be due to HMRC. A worrying time, with the slightly good news that HMRC seem to have adopted a conciliatory approach to agreeing repayment terms because they understand that EBT participators were not trying to evade tax but merely avoid it using a scheme which is now shown to be inappropriate.

The views in this article are those of Michael J M Reid, licensed insolvency practitioner and partner of Meston Reid & Co, chartered accountants, Aberdeen. They do not purport to represent those of the firm in general.