In this article Richard Gray Barrister gives an overview on the use of Employee Benefit Trusts and considers, even though the aggressive EBT schemes are a thing of the past, whether they are still being considered principally as a vehicle to avoid Inheritance Tax (IHT) and the potential pitfalls should that occur.
Having just finished a lengthy conference with a client, I was reminded of something a colleague of mine said, namely that; “Google is not kind to EBTs”. If you were to Google the point, that appears to be correct and in this case the Client threw many questions at me surrounding the abusive arrangements for which they had previously been used. We now know all too well the effect of those arrangements and the misery they generated.
Aggressive schemes apart, there is very much a place for an EBT within the context of proper business planning and recently, Elysium Law has advised upon their use in the sale of a trading company where, prior to implementation, HMRC gave clearance.
Regrettably, there is still a temptation to use them purely as a vehicle for avoiding IHT and in this article I look at the consequences of the misuse of an EBT and simply ‘getting it wrong’.
Be warned of the use of an EBT in, for example, a small family company who just after incorporation of an investment portfolio now wants to avoid IHT by placing the shares into an EBT. It won’t work!
What is an EBT?
An EBT is a type of discretionary trust set up to fall within the definition of a trust for the benefit of employees within the provisions of Section 86 of the Inheritance Tax Act 1984 (IHTA 1984). This provides exemptions from inheritance tax (IHT) for certain transactions involving qualifying EBTs.
Special Treatment of Section 86 Trusts
The following should be noted in relation to a section 86 trust
It is not a relevant property trust;
A section 86 trust is not a relevant property trust. Relevant property trusts are subject to the specific inheritance tax regime in Chapter III, Part III of the Inheritance Tax Act 1984. Therefore, a section 86 trust it is not subject to the IHT charges such as the exit charge and the ten-yearly charge.
Transfer of Value to an EBT
If a close company makes a transfer of value to an EBT, this will be a chargeable transfer, apportioned to the participators under section 94, IHTA 1984.
There are, however, four possible reliefs and exemptions that may be available:
- Dispositions not intended to confer a gratuitous benefit;
- Dispositions allowable for corporation tax.
- Disposition for the benefit of employees.
- Business property relief.
Section 13 of the Act deals with transfers of value into the Trust.
Consideration is then to be given to the effects of Section 239 of the Taxation of Chargeable Gains Act 1992., which gives the exemption of CGT for the ‘transfer in’ of the assets.
Section 28, IHTA 1984 provides that a transfer of value by an individual to an EBT will be an exempt transfer where the following condition is satisfied:
- The EBT is a section 86 trust with restricted beneficiaries.
However, the reliefs granted are subject to anti avoidance provisions without which it would be easy to use the EBT exemptions to transfer wealth from one generation of a family to another without adverse IHT and CGT consequences
Should an EBT be considered abusive by HMRC, then the trust will be treated as a Relevant Property Trust and a short contrast with that regime, as opposed to EBTs, must be considered.
Inheritance Tax considerations
Lifetime gifts into discretionary trusts are chargeable lifetime transfers (CLTs). IHT will be charged at the lifetime rate of 20% on the amount above the settlor’s nil rate band. There is
10-year periodic charge
Discretionary trusts are ‘relevant property’ trusts because the trust assets are not included in the taxable estate of any of the beneficiaries, the trust itself will be assessed to IHT. That means that on each 10-year anniversary the trust is taxed on the value of the trust less the nil rate band available to the trust. The rate they pay on this excess is 6% (calculated as 30% of the lifetime rate, currently 20%).
Capital Gains Tax – Gifts into trust
Lifetime gifts of existing assets into trust, other than gifts of cash or the assignment of investment bonds, will be disposals for CGT.
During the life of the trust
If the trustees dispose of trust assets the gains are calculated in the same way as for an individual and taxed at the trust rates of CGT. The trust rates are 20% or 28% for residential property.
If the EBT is reclassified by HMRC as a Relevant Property Trust, then penalties and interest will apply and therefore extreme caution must be exercised when advising on the set up of the EBT
DoTAS and the final word
Again, a detailed consideration of these provisions is beyond the scope of this article, but advisors should consider whether placing shares in a small investment company with no employees will fall within the DoTAS legislation. In my view it does and the temptation to do this must be avoided
IHT hallmark a revision from the previous legislation
The IHT arrangement Regulations 2017 were made on 29 November 2017 and came into force on 1 April 2018, replacing the previous IHT hallmark.
Arrangements to which the IHT hallmark applies
The IHT hallmark applies to arrangements if it would be reasonable to expect an informed observer to conclude that both of the conditions below are met.
The main purpose, or one of the main purposes, of the arrangements is to enable a person to obtain one or more of a list of specific advantages in relation to IHT (tax advantage).
The specific advantages are:
- The avoidance or reduction of a relevant property entry charge, the ten-year anniversary and exit charges.
(Regulation 4(2), IHT Arrangements Regulations 2017.)
The arrangements involve one or more contrived or abnormal steps without which a tax advantage could not be obtained.
(Regulation 4(3), IHT Arrangements Regulations 2017.)
EBTs if used properly have a significant place in Tax and Business planning. If you want further advice upon the use EBTs, EOTs and of an EBT upon the proposed sale of trading company, then contact us via email at email@example.com or call 0151 328 1968