Below is a technical release form Buckingham Wealth issued in Nov. I'm interested in hearing what knowledgeable in this area think of what's been said below.
HMRC SUFFERS MAJOR DEFEAT IN RANGERS CASE
The headline might conflict with readers’ expectations, if they have been digesting internet news
reports, all written before publication of the actual Appeal Court judgment:
https://www.scotcourts.gov.uk/search...0-ff0000d74aa7
THE DECISION BENEFITS
What would you think of an appeal court judgment, binding on Tax Tribunals, which said of employee benefit trusts:
1. contributions are tax deductible for the employer;
2. neither employer nor employee is to be taxed on trust investment returns;
3. movement of funds from main trust to sub-trusts is not an event giving rise to income tax
liability on employee;
4. payment of cash funds out of trust –even to the employee - is not an event giving rise to
income tax liability on employee;
5. loans to the employee are not taxable as his income;
6. loans to the employee are deductible against his IHT estate;
7. this is not tax avoidance.
You would no doubt say: that is a nice decision to have. It now exists: The Advocate General For Scotland Against A Decision Of The Upper Tribunal In Relation To Assessments To Tax Made On (1) Murray Group Holdings Limited & Ors [2015] CSIH 77.
THE DECISION ON REDIRECTED EARNINGS
So, you ask, why are the internet news feeds reporting doom and gloom? [For example: HMRC wins Rangers tax case appeal - BBC News ]. That headline is about the fact that the Court did find that the money which was directed into the EBT was already promised to each player as extra wages. As the BBC reports it: The judges ruled that if income was derived from an employee's services, in their capacity as an employee, it was an emolument or earnings and "thus assessable to income tax".
That is a correct statement of the law. It is exactly what was written in Baxendale-Walker’s 1997 book The Law & Taxation of Remuneration Trusts. Citing from the 2012, 2nd Edition:
6.2.2 Contractual Remuneration Allocation
...The principle is clearly correct. Where the terms of a contract between an executive and an employer provide that any of the remuneration consideration, which the employer is bound to pay, is to be paid not to the employee but to a third person, the employer performs its contractual obligation by making such payments. The payment forms part of the consideration for the employer's promise to provide service and the provision of the employee's service under the contract is the "source" of the payment: that, of course, is a Schedule E source. It is trite contract law that consideration need not move to the promisor: see Re Wyvern Developments Ltd [1974] 1 WLR 1097.
Payments under Contractual Remuneration Allocation arrangements clearly constitute a payment of PAYE employment income for the purpose of PAYE (see section 683 ITEPA 2003).
...where the executive authorises the Founder to pay a sum of remuneration to a third party, then the Founder merely acts as payment agent for the executive: the fiscal liability arising in respect of the emolument is not affected by the manner in which the emolument is applied.
As a practical matter, such Contractual Remuneration Allocation arrangements do disadvantage the executive, since a taxable sum must be brought into account for income tax purposes without retention of the funds to pay the taxation liability. It is therefore sensible to contract for such arrangements on a "net of income tax PAYE and NICs (if applicable)" basis, so that the economic effect is congruent with the fiscal consequence.
As the Rangers judgment now says:
[56] The fundamental principle that emerges from these cases appears to us to be clear: if income is derived from an employee’s services qua employee, it is an emolument or earnings, and is thus assessable to income tax, even if the employee requests or agrees that it be redirected to a third party.
[60] In relation to footballers, when a contract of employment was concluded, an additional side-letter provided for a discretionary trust payment (paragraph [14] above). It seems to us to be self-evident that the obligations in the side-letter were part of the employee’s employment package, and provided him with additional remuneration. They were negotiated as part of the total employment package; ... Once it is accepted that the bonus payments represented consideration for a footballer’s services qua employee, it inevitably follows that those payments represented emoluments or earnings of the footballer in question.
[61] ...After payment had been made by the employer, the employee could not be subject to further liability to income tax in respect of those monies. It follows that the existence of the trust arrangements and the loans made by trustees to the employee in question were irrelevant to the question of whether there was a redirection of earnings.
So, 18 years on from 1997, The Law & Taxation of Remuneration Trusts analysis is vindicated.
As Paul Baxendale-Walker said in BBC interview at the start of the Rangers case, the club had not used the EBT vehicle properly, because the club employer had clearly made binding pay arrangements with players, then simply tried to redirect those wages into a trust. The Appeal Court has agreed: once an amount is agreed to be due to an employee, he can’t get rid of the income tax liability by having the sum paid to his wife, his mum or a trust.
THE DECISION CONSEQUENCES
Remember that all of this is relevant anyway only in the realm of Employee benefit trusts, not other sorts.
So long as an employer/employee are not silly enough to agree a total pay package (including bonus), the Rangers decision is irrelevant. The decision only applies to “redirected earnings” or what the 1997 Book called “Contractual Remuneration Allocation.” Indeed, HMRC may now be looking at a massive bill for repayment of tax in EBT cases where it is now not shown that there was Rangers-type Contractual Remuneration Allocation.
The Appeal Court has certainly struck a massive blow against HMRC with the Decision Benefits listed above. Loans, or anything else that comes out of the trust are not taxable. Loans count for IHT deduction purposes. Putting money into sub-trusts doesn’t generate income tax liability. Employees and employers are not taxable on trust income and gains. The employer gets a tax deduction. The Appeal Court has restated in definitive language much of the key principles of the 1997 Book.
There is more. This next bit is for tax geeks only though. The Rangers decision has driven a coach and horses through the 2011 “Disguised Remuneration” legislation.
[69] In this case we have held that the payment made by the employing company to the Principal Trust is subject to income tax but payments out of the trust will not be so subject. The funds in question will be held by the relevant trustee as trust capital, and any payment of the fund originally received from the employing company will accordingly be treated for tax purposes as a capital payment out of a trust. The only liability to income tax is on income earned by the trustees, for example by investment of the trust funds. In these respects, however, the situation is no different from an employee who uses part of his post-tax income to fund a trust for the benefit of his family. In such a case the amounts that he received as income are transformed into capital in the hands of the trustees, and become subject to the ordinary tax regime governing funds held in trust. There is no double taxation.
So, we now have a situation where:
(i) the Appeal Court says that redirected earnings pay tax at source (at the employee/employer
level when the money goes into trust);
(ii) the 2011 legislation says the opposite (that it is when money moves into sub-trust or comes
out entirely that employment income tax is payable); but
(iii) the Appeal Court says that the money that went into trust cannot – on elementary tax law
principles – ever be taxed again as employment income: thus
(iv) the taxing provisions of the 2011 legislation are incompatible with elementary income
tax law as declared by the Appeal Court.
That is very much a problem for HMRC and for advisors to EBT clients. One can quite see those advisors wanting back a lot of client tax money paid under the 2011 legislation.
HMRC SUFFERS MAJOR DEFEAT IN RANGERS CASE
The headline might conflict with readers’ expectations, if they have been digesting internet news
reports, all written before publication of the actual Appeal Court judgment:
https://www.scotcourts.gov.uk/search...0-ff0000d74aa7
THE DECISION BENEFITS
What would you think of an appeal court judgment, binding on Tax Tribunals, which said of employee benefit trusts:
1. contributions are tax deductible for the employer;
2. neither employer nor employee is to be taxed on trust investment returns;
3. movement of funds from main trust to sub-trusts is not an event giving rise to income tax
liability on employee;
4. payment of cash funds out of trust –even to the employee - is not an event giving rise to
income tax liability on employee;
5. loans to the employee are not taxable as his income;
6. loans to the employee are deductible against his IHT estate;
7. this is not tax avoidance.
You would no doubt say: that is a nice decision to have. It now exists: The Advocate General For Scotland Against A Decision Of The Upper Tribunal In Relation To Assessments To Tax Made On (1) Murray Group Holdings Limited & Ors [2015] CSIH 77.
THE DECISION ON REDIRECTED EARNINGS
So, you ask, why are the internet news feeds reporting doom and gloom? [For example: HMRC wins Rangers tax case appeal - BBC News ]. That headline is about the fact that the Court did find that the money which was directed into the EBT was already promised to each player as extra wages. As the BBC reports it: The judges ruled that if income was derived from an employee's services, in their capacity as an employee, it was an emolument or earnings and "thus assessable to income tax".
That is a correct statement of the law. It is exactly what was written in Baxendale-Walker’s 1997 book The Law & Taxation of Remuneration Trusts. Citing from the 2012, 2nd Edition:
6.2.2 Contractual Remuneration Allocation
...The principle is clearly correct. Where the terms of a contract between an executive and an employer provide that any of the remuneration consideration, which the employer is bound to pay, is to be paid not to the employee but to a third person, the employer performs its contractual obligation by making such payments. The payment forms part of the consideration for the employer's promise to provide service and the provision of the employee's service under the contract is the "source" of the payment: that, of course, is a Schedule E source. It is trite contract law that consideration need not move to the promisor: see Re Wyvern Developments Ltd [1974] 1 WLR 1097.
Payments under Contractual Remuneration Allocation arrangements clearly constitute a payment of PAYE employment income for the purpose of PAYE (see section 683 ITEPA 2003).
...where the executive authorises the Founder to pay a sum of remuneration to a third party, then the Founder merely acts as payment agent for the executive: the fiscal liability arising in respect of the emolument is not affected by the manner in which the emolument is applied.
As a practical matter, such Contractual Remuneration Allocation arrangements do disadvantage the executive, since a taxable sum must be brought into account for income tax purposes without retention of the funds to pay the taxation liability. It is therefore sensible to contract for such arrangements on a "net of income tax PAYE and NICs (if applicable)" basis, so that the economic effect is congruent with the fiscal consequence.
As the Rangers judgment now says:
[56] The fundamental principle that emerges from these cases appears to us to be clear: if income is derived from an employee’s services qua employee, it is an emolument or earnings, and is thus assessable to income tax, even if the employee requests or agrees that it be redirected to a third party.
[60] In relation to footballers, when a contract of employment was concluded, an additional side-letter provided for a discretionary trust payment (paragraph [14] above). It seems to us to be self-evident that the obligations in the side-letter were part of the employee’s employment package, and provided him with additional remuneration. They were negotiated as part of the total employment package; ... Once it is accepted that the bonus payments represented consideration for a footballer’s services qua employee, it inevitably follows that those payments represented emoluments or earnings of the footballer in question.
[61] ...After payment had been made by the employer, the employee could not be subject to further liability to income tax in respect of those monies. It follows that the existence of the trust arrangements and the loans made by trustees to the employee in question were irrelevant to the question of whether there was a redirection of earnings.
So, 18 years on from 1997, The Law & Taxation of Remuneration Trusts analysis is vindicated.
As Paul Baxendale-Walker said in BBC interview at the start of the Rangers case, the club had not used the EBT vehicle properly, because the club employer had clearly made binding pay arrangements with players, then simply tried to redirect those wages into a trust. The Appeal Court has agreed: once an amount is agreed to be due to an employee, he can’t get rid of the income tax liability by having the sum paid to his wife, his mum or a trust.
THE DECISION CONSEQUENCES
Remember that all of this is relevant anyway only in the realm of Employee benefit trusts, not other sorts.
So long as an employer/employee are not silly enough to agree a total pay package (including bonus), the Rangers decision is irrelevant. The decision only applies to “redirected earnings” or what the 1997 Book called “Contractual Remuneration Allocation.” Indeed, HMRC may now be looking at a massive bill for repayment of tax in EBT cases where it is now not shown that there was Rangers-type Contractual Remuneration Allocation.
The Appeal Court has certainly struck a massive blow against HMRC with the Decision Benefits listed above. Loans, or anything else that comes out of the trust are not taxable. Loans count for IHT deduction purposes. Putting money into sub-trusts doesn’t generate income tax liability. Employees and employers are not taxable on trust income and gains. The employer gets a tax deduction. The Appeal Court has restated in definitive language much of the key principles of the 1997 Book.
There is more. This next bit is for tax geeks only though. The Rangers decision has driven a coach and horses through the 2011 “Disguised Remuneration” legislation.
[69] In this case we have held that the payment made by the employing company to the Principal Trust is subject to income tax but payments out of the trust will not be so subject. The funds in question will be held by the relevant trustee as trust capital, and any payment of the fund originally received from the employing company will accordingly be treated for tax purposes as a capital payment out of a trust. The only liability to income tax is on income earned by the trustees, for example by investment of the trust funds. In these respects, however, the situation is no different from an employee who uses part of his post-tax income to fund a trust for the benefit of his family. In such a case the amounts that he received as income are transformed into capital in the hands of the trustees, and become subject to the ordinary tax regime governing funds held in trust. There is no double taxation.
So, we now have a situation where:
(i) the Appeal Court says that redirected earnings pay tax at source (at the employee/employer
level when the money goes into trust);
(ii) the 2011 legislation says the opposite (that it is when money moves into sub-trust or comes
out entirely that employment income tax is payable); but
(iii) the Appeal Court says that the money that went into trust cannot – on elementary tax law
principles – ever be taxed again as employment income: thus
(iv) the taxing provisions of the 2011 legislation are incompatible with elementary income
tax law as declared by the Appeal Court.
That is very much a problem for HMRC and for advisors to EBT clients. One can quite see those advisors wanting back a lot of client tax money paid under the 2011 legislation.
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