The Court of Sessions in Scotland have overturned previous Tribunal decisions and found in favour of HM Revenue & Customs. The judges have decided that payments by Rangers FC to the principal trust of an employee benefit trust amount to “a mere redirection of emoluments and earnings” and therefore were subject to income tax and national insurance.
In summary, the arrangement worked as follows. Rangers FC would make payments to the “principal trust” of an employee benefit trust. This would be an offshore discretionary trust for the benefit of employees and their families of the employer’s group generally. The trustees of the principal trust would then make payments to a “sub-trust” which would be for the benefit of a particular employee and their family. The sub-trust would then make loans to the employee at a discounted rate of interest. The intended purpose of such an arrangement was to defer income tax and national insurance until such time as the employee received a payment or benefit from the sub-trust. If the employees paid the official rate of interest or higher on the loans they received, then no benefit would arise. In addition the outstanding loans would be a deduction in their estate for inheritance tax purposes.
In the earlier Tribunal decisions it was held that the payments to the principal trust fell short of an absolute entitlement by a particular employee to the money. This is because the principal trust had a number of discretionary beneficiaries. The trustees of the principal trust then made a decision under their powers granted in the trust deed to make an appointment to a particular sub-trust.
The appeal judges had a different opinion and decided that the question in law was whether payments to the principal trust were consideration for the employees’ services, whether they were absolute payments or not was irrelevant. If they were payments in respect of the footballers then the payments were derived from their employment.
They decided that, on the facts, the payments to the principal trust were earnings at that step and not at a later step when payments were transferred to the sub-trust. The principles of long standing case law were applied, that the redirection of employment earnings to a third party does not stop the payment from being taxable as employment earnings.
This case is likely to have a significant impact on the many beneficiaries of other offshore employee benefit trusts as HM Revenue & Customs may well feel emboldened to challenge the efficacy of such arrangements. But it is helpful to consider some of the reasons why Rangers FC actually lost.
In my opinion there were several factors which were decisive to the judgment. Firstly, individual footballers had employment contracts with a side-letter which covered the payment of bonuses into an employee benefit trust.
Lord Drummond Young said “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 as an employee, it inevitably follows that those payments represented emoluments or earnings of the footballer in question.”
Secondly, the payments to the principal trust were identifiable to individual footballers which were then transferred to the individual footballer’s sub-trust. Presumably this was to enable the footballer and their agent to know that the footballer was being paid exactly what he was entitled to. This was their undoing as common sense prevailed, that each payment to the payment to the principal trust was actually on behalf of an individual. This led to Lord Drummond Young’s conclusion “we are of opinion that the sums received by the trustee of the Principal Trust and in due course by the trustees of the sub-trusts amounted to a mere redirection of income and thus constituted emoluments or earnings of the employees in question”.
In my view whether an employment benefit trust arrangement will be successfully challenged by HM Revenue or not will depend on the facts. For example a lump sum transferred to an employee benefit trust on behalf of a number of beneficiaries, or the making of discretionary payments (to which an employee was not contractually entitled) to an employee benefit trust can be distinguished from the Rangers FC case.
What is interesting is that the judges in this case did not challenge the nature of the loans and seek to reclassify them as an emolument. This argument has been run unsuccessfully by HM Revenue several times. Thus loans made from employee benefit trusts prior to the implementation of the so called disguised remuneration regime on 9th December 2010 may still be defendable as loans.
The message is, expect more employee benefit trusts and the beneficiaries to be challenged.
6 November 2015