Staying the course

With income tax rates at the highest levels since the 1980s, high-net-worth individuals (HNWI) are more interested than ever in finding ways to reduce their tax liabilities and their advisers are under pressure to offer innovative solutions.

When the highest rate of income tax increased to 50 per cent from April 2010, the use of structures such as employee benefit trusts (EBT) and employer-funded retirement benefit schemes (EFRBS) to provide tax efficient remuneration strategies grew in popularity. In some cases these structures would obtain a corporation tax deduction for the sums contributed to the EFRBS/EBT and the funds would then be passed to the individual in the form of a loan, attracting only a benefit in kind charge. This meant overall tax exposure could be as low as two per cent – a substantial saving compared with the 50 per cent rate.

Calling time

But HMRC’s announcement in December 2010 heralded the end of tax planning using EFRBSs and EBTs as we knew it, with the introduction of draft legislation designed to counter tax avoidance on ‘disguised remuneration’. These provisions are aimed at preventing the avoidance or deferral of income tax on payments and benefits that would otherwise be subject to income tax and national insurance on the basis that they are rewards in connection with employment. The measures announced in December last year were given effect from 6 April 2011 and anti-forestalling measures were introduced to cover similar employment-related payments and benefits; for example, interest-free loans, made available between ?9 December 2010 and 5 April 2011.

The new disguised remuneration legislation is covered in section 26 and schedule 2 of the Finance Act 2011. It runs to some 68 pages and HMRC guidance issued on the topic is in ?excess of 200 pages. An expression used to describe this legislation could be ?‘a sledgehammer to crack a nut’.

Whereas an employee receiving an interest-free loan from their employer directly would be subject to a benefit in kind charge and the employing company potentially liable to a repayable 25 per cent corporation tax charge under section 455 of the Corporation Tax Act (CTA) 2010, a similar loan provided to an employee through a third party (for example, an EBT) would be subject to an immediate PAYE (at rates up to 50 per cent) and NI charge in the same way a bonus would be. Furthermore, on repayment of the loan to the EBT, no refund of tax or NI paid is available to the employee.

The new legislation is very wide reaching and can cover situations where funds in an EBT or EFRBS (or any other third party) are simply ‘earmarked’ for a particular employee without any actual payment to them, where loans are made to employees by the third party (other than on commercial terms) or where assets are made available by the third party for use by the employee. These so-called ‘relevant steps’ can result in large, non-repayable income tax and national insurance charges, based ?on the value of the ‘relevant step’ for ?any employee receiving such a benefit from a third party.

Structured approach

So, does this spell the end of tax planning using this type of structure? Potentially not. Even in the wake of the provisions published in December 2010 planners were quick to offer solutions that aimed to negotiate the tough new rules. Despite the length and complexity of the new provisions there still appears to be scope to make use of these structures within the confines of these new provisions.

For example, the legislation allows a deduction against the value of the ‘relevant step’ if a payment is made to an employee in exchange for an asset transferred by the employee to the third party. The deduction will equate to the market value of the asset transferred and will mean that no income tax or national insurance charge will arise on such a transaction, provided the amount received for the asset by the employee does not exceed its market value.

What this means is that an employee could sell an asset to the third party in exchange for cash payment without incurring an income tax charge. Of course, you would need to consider the overall tax impact of the disposal of such an asset on the employee. But what if, for example, an employee possessed a valuable asset that currently stands at a capital loss? This could provide a neat method of realising the capital loss and withdrawing funds from, for example, an EFRBS, without falling foul of the new legislation. Even where the asset in question has an inherent capital gain, its disposal may only give rise to a capital gains tax charge at ten per cent, as opposed to the potential 50 per cent income tax charge on otherwise withdrawing the cash. The sale of an asset could also be considered to satisfy a debt that currently exists in relation to a previous loan made by the third party.

Seeking shelter

So, with the use of EBTs and EFRBSs now restricted, what other planning solutions are on offer to HNWI clients?

The large gap between income and corporate tax rates could provide an opportunity for planning in a partnership situation. Without planning, all partnership profits are subject to ?income tax rates up to 50 per cent, ?even if the partners do not draw their entire profit share. The introduction ?of a ‘corporate partner’ to a partnership could provide a means of sheltering some of these profits at corporate rates, much lower already and set to reduce further. The current rates of corporation tax range between 20 per cent and ?27.5 per cent, profit dependent – substantially lower than income tax rates. There are pitfalls to negotiate in setting up such a structure, but, with careful planning around introducing a company as a partner, substantial savings can ?be achieved.

The status of a Scottish partnership as a separate legal person, distinct from the partners making up the partnership, also offers a tax-planning opportunity. Whereas a loan to a limited liability partnership (LLP) or an English partnership from a close company would potentially lead to a tax charge under section 455 CTA 2010, the same loan to a Scottish trading partnership, as a separate legal person, will not. This therefore presents an opportunity to extract cash from a trading company as a loan to a Scottish trading partnership that could be used to fund, for example, a property investment made through the partnership. This type of planning could be carried out rather than direct cash extraction by an individual to fund the same investment which would be difficult, if not impossible, to achieve without incurring a tax charge.

Another potential avenue of tax planning relates to the payment of private education costs. Without planning, our HNWI clients pay school fees from taxed income. With careful structuring, it may be possible to set up a trust, settled by a relative other than the parents for the benefit of the children, that receives dividend income that is used to settle school fees directly. With the correct trust structure in place, the dividend income becomes assessable on the children themselves and more than likely will be free of tax liability entirely, thus saving the parents tax at rates up to 50 per cent.

HMRC will continue to try to ?block reasonable and legal methods ?of mitigating tax. However, with ?careful and advance planning there ?are still opportunities out there to ?be exploited. n

Rhona MacKinnon is a chartered ?tax adviser and assistant director ?in the tax consultancy group at Campbell Dallas