New HMRC guidance on IHT treatment of gifts to an employee benefit trust
26 October 2009
Revenue and Customs Brief 49/09 sets out HMRC’s view on the inheritance tax (IHT) position when contributions are made to an employee benefit trust (EBT) by a certain types of privately held company. HMRC have taken a hard line in Brief 49/09, presumably to deter taxpayers from considering the future use of EBTs as part of their tax planning.
The basic inheritance tax position
Inheritance tax is charged on "transfers of value." In broad terms, a transfer of value is a gift made with gratuitous intent, generally not including arm’s length commercial transactions. Transfers of value can be made as lifetime gifts as well as on death.
A contribution made by a "close company" to an EBT may constitute a transfer of value which attracts a charge to IHT. A close company is a company which is under the control of five or fewer "participators" (broadly, shareholders), or any number of participators who are also directors. Where a close company makes a transfer of value, the transfer is apportioned amongst the participators. For example, if a company with two participators makes a contribution of £1 million to an EBT, each participator can be deemed to have made a transfer of value of £500,000, on which IHT could be payable. The transferor company is primarily liable for any tax which is due and if the company does not pay within the appropriate timeframe, the participators can become liable personally.
Transfers to an EBT – relief from inheritance tax
There are four possible ways of avoiding a charge to IHT when a close company makes a contribution to an EBT:
- under section 10 of the Inheritance Tax Act 1984 ("IHTA 1984"), which applies where there was no intention to confer a gratuitous benefit
- under section 12 IHTA, which applies where a corporation tax deduction is available in respect of the transfer
- under section 13 IHTA, which (in broad terms) applies where the participators in the close company cannot benefit from the EBT, subject to some limitations on its scope
- if the transfer qualifies for business property relief.
Under section 10 IHTA, if it can be shown that a transfer of value arose in circumstances where the close company did not intend to confer any gratuitous benefit and the payment was made at arm’s length, or was such as might have been made at arm’s length, the transfer of value is not subject to inheritance tax. Where it can be shown that the creation of the EBT was motivated by a genuine desire to remunerate the employees and officers of a close company establishing it, section 10 will arguably be in point.
Section 12 IHTA provides that if a close company is entitled to a corporation tax deduction on the transfer to an EBT, the transfer of value is not subject to inheritance tax. The decision in Dextra Associates Ltd v MacDonald, together with the introduction of Schedule 24 Finance Act 2003 (now transposed into the Corporation Tax Act) prevented a corporation tax deduction on contributions to an EBT unless and until the amounts were paid out to the employees in taxable form. It is not clear how section 12 IHTA should be applied where a tax deduction has been deferred, but possibly not denied altogether.
Section 13 IHTA provides a general rule that a disposition made to an EBT by a close company, provided the EBT satisfies certain conditions, is not a transfer of value. However, this rule is disapplied where the EBT permits any of the property transferred to be applied at any time for the benefit of a participator with a shareholding of more than 5%. This is subject to a further proviso: a shareholder with more than 5% can benefit from an EBT as long as that benefit comes in the form of a payment subject to income tax.
Finally, where an EBT has been established by a trading company, any transfer of value may qualify for business property relief, which could result in no charge to IHT arising. However, it is not straightforward to apply the business property relief rules in the case of a deemed transfer of value by participators under section 94. There are arguments both for and against business property relief applying on a transfer to an EBT, and the availability of the relief will depend on the facts of each case.
HMRC’s interpretation of the law
Brief 49/09 takes a hard line in relation to the reliefs available under sections 10, 12 and 13 IHTA, and does not address the possibility of business property relief being available.
As regards section 10 (no gratuitous benefit), HMRC have stated that, in their view, "it will normally be difficult to show that section 10 is satisfied at the date the contributions were made to the trust. HMRC take the view that it is the possibility of gratuitous intent at the date the contribution is made that we have to consider." There is little analysis to back up HMRC’s view, simply a statement that that it will "normally be difficult" to show that the section applies. Arguably, a contribution to an EBT made on arm’s length terms to incentivise and remunerate employees does not involve any gratuitous intent, so section 10 could be in point.
HMRC’s interpretation of section 12 (corporation tax deduction available) is that "relief from the inheritance tax charge is only available…to the extent that a deduction is allowable to the company for the tax year in which the contribution is made." In other words, there will be no relief if a corporation tax deduction is deferred to a later year, even if it later becomes allowable. Again, this is a hard line. HMRC’s view would deny section 12 relief to dispositions which had in fact proved to be allowable for corporation tax. This would, prima facie, defeat the purpose of the section.
HMRC take the view that section 13 (no benefit to participators) will not apply "where the trust deed specifically purports to exclude the participators from benefit but nevertheless the participators do benefit, [for example] by payment to them of loans or by assigning funds from the employee benefit trust on sub-trusts for their benefit and that of their family." These are references to common planning arrangements which a court recently held did not to give rise to employment income tax/ NICs charges on earnings, despite HMRC taking the contrary view. HMRC’s view on the IHT treatment of such arrangements will not be a surprise to most practitioners.
The intention behind Brief 49/09 is probably to deter taxpayers from using EBTs for tax planning purposes in the future, and HMRC have already attacked what they see as unacceptable tax planning using EBTs through the courts. The publication will also impact on EBTs which have already been set up. Reliance may have been placed on interpretations of the law which conflict with HMRC’s now clearly stated position. In light of the pessimistic terms of Brief 49/09, it would be sensible to conduct a review of the IHT status of existing EBTs.
However, the IHT analysis is not as bleak as the picture painted by HMRC. The availability of relief from IHT will depend on the facts of each case, including the terms of the trust, the extent to which the participators are excluded from benefit and the availability of business property relief.