Disguised Remuneration

An Update

On 21 February, HMRC released its long-anticipated Frequently Asked Questions (FAQs) – labeled "Version 1" - following the publication of its disguised remuneration proposals on 9 December 2010. The informal consultation process ended on 9 February and a number of areas where refinements to the proposed legislation have been identified. These FAQs, therefore, cover the main themes to emerge from consultation; unfortunately, there is no comment either in respect of how the proposed regime would operate following death (as charges continue to arise by reference to the employee), or in relation to how NIC will apply to earnings resulting from a relevant step being taken. It now looks highly unlikely that we will see a further draft of the proposed legislation before the publication of the 2011 Finance Bill on 31 March; publication of FAQs "Version 2" is also anticipated at or around that time. One thing for certain is that the legislation finally enacted will not be any less complex!

Planning without sight of updated legislation can be problematic and carries risk. It is not possible to interpret FAQs like legislation; the devil is always in the detail, and in any event anything put forward on 31 March may be subject to further amendment as it passes through the normal parliamentary process. However, the FAQs do give a reasonable insight into policy, and there may be enough here for decisions to be made in areas where there is no doubt about the applicability of the legislation when enacted – just as well, given that the proposals will come fully into effect in six weeks.

The focus of this update is not to comment on each of the 33 FAQs set out in "Version 1". Rather, it is intended to outline the possible actions worthy of consideration by stakeholders (employers, employees, trustees and beneficiaries) in the next six weeks. By way of background, we have previously produced a more general commentary on the topic, and this update develops our previous analysis in response to the FAQ's. The disguised remuneration proposals and the interaction with current rules are highly complex, and there are many potential pitfalls. As always, professional advice should be sought before any actions are undertaken.

EBTs and EFRBS – Funding pre 6 April 2011

HMRC repeated its view of arrangements involving third parties under current law at FAQ29:

"... some of the types of transaction ... are not accepted by HMRC as effective in avoiding tax under existing law. Such transactions include the earmarking of funds held in a discretionary trust before 6 April 2011 as well as other transactions where a realistic view of the facts is that earnings have been paid. HMRC will continue to challenge such transactions under the existing law, including in litigation where necessary."

Our comments in this update are made against this backdrop. HMRC has twice litigated on the "earmarking as earnings" point in the last 9 years (see Dextra at the Special Commissioners, and Sempra Metals), without success. The EBT and EFRBS arrangements we have been involved with are "general" in nature and have not been implemented to otherwise "disguise" remuneration (e.g. loan schemes). Notwithstanding HMRCs stated position, most employers with existing arrangements have decided to proceed with funding EBTs and EFRBS as part of the normal remuneration cycle. The proposed legislation applies only to funds or assets "earmarked" with effect from 6 April 2011, so prior "earmarking" (for example, by way of appointment to a sub-trust or an allocation) should result in deferral of tax and NIC as well as most of the other advantages EBTs and EFRBS always afforded.

The main concern amongst EBT and EFRBS stakeholders has been that, under the proposed legislation as drafted, investments made and realised by the trustee would give rise to an employment tax charge and a NIC liability. These fears have been allayed by FAQ33 and FAQ12 (respectively) and there should be no tax consequences for an employee unless and until a benefit is provided.

As a result of the policy framework put forward in these FAQs, there may in fact be an incentive to make further funding arrangements before 6 April 2011, particularly to an EFRBS (see below). We would be happy to advise on this approach, including on implementation in situations where conditions on the provision of remuneration will not have been satisfied prior to 6 April 2011.

EBTs – Strategies for all Beneficiaries

FAQ31 reminds us that the proposed legislation applies to all relevant steps taken after 5 April 2011 (or after 8 December 2010 if the step is one that falls within anti-forestalling provisions) regardless of when earmarking by way of sub-fund appointment or otherwise took place. Any benefits provided whilst the proposed legislation applies will be subject to employment tax and NIC. In terms of strategies for mitigating exposure to the proposals, the position where the "primary" beneficiary continued to be in employment with the settlor employer on 6 April 2010 (a "Current Employee") is more limited in terms of what may be done. The main issues are:

The inability to access funds by way of loan in almost all situations (the exemption for loans on...