Ten minute tutorial – Employee Benefit Trusts (EBTs)

Graham Callard, a tax adviser
at law firm Howard Kennedy offers a brief introduction to a system which offers
a tax-efficient method of providing benefits to staff..

What is an EBT?

An Employee Benefit Trust (EBT)
is a discretionary trust which can be used by businesses to provide various
benefits to directors and employees. When established correctly, EBTs are
extremely tax-efficient.

EBTs are suitable for both
corporate and non-corporate businesses with typically more than 10 to 15
employees (including directors or salaried partners) and profits of at least
£100,000 per annum.

The employer’s tax position

If the EBT is established
correctly, the employer will receive tax relief on contributions made to the EBT
and – given the discretionary nature of the trust – the funds will not be
subject to PAYE or NIC until received absolutely by an employee, for example on
the payment of a bonus by the Trustee.

If the business is a
non-corporate – for example a partnership or a sole trader – the partners or
sole proprietor must be excluded from benefiting from the EBT.  Failure to do so will preclude any tax
relief on contributions made to the EBT.

What kind of benefits can
be provided through an EBT?

Once formed in accordance
with the Trust Deed, an EBT may provide benefits to directors, salaried
partners and other employees. These benefits can include:

(a)        Loans
– interest-free on which no repayments are made (within the perpetuity period of
80 years). The loan may be used for any purpose.

            Uses      
Repay mortgages and other debts;

1.      Avoid
tax on car benefit;

2.      Solve
directors’ overdrawn loan accounts problems;

3.      Introduce
capital to the business.

Tax
liability
: Assuming the director or employee is a higher rate tax payer,
only 2.2% of the loan per annum will be payable as income tax, compared to 40%
plus NIC if a bonus was paid.

(b)        Use of assets – EBTs may purchase
assets which are included in an employee’s overall benefit package. These
assets could include villas, boats, IT equipment and furniture for the home etc.

            Uses    – villas and boats which can be used for
holidays;

Tax
liability
: Early tax relief on assets purchased and tax relief on assets
which would not normally qualify. The business has effectively obtained 100 per
cent tax relief on the purchase of the asset. For the employee, normal benefit
in kind rules apply which will depend on the type of asset used.

Useful ideas
for using EBTs

The Trustees are
normally empowered to provide benefits to employees such as loans and the use
of trust assets through the EBT. The advantage of using the EBT in this way is
that employees will only pay income tax on the benefit in kind arising.

For example, if it is clear
that an employee is going to utilise his bonus to buy some furniture for his
home and he is not concerned with any questions of ownership, then it makes
sense for that asset to be provided by the EBT rather than for the employee to
purchase the furniture from a bonus that has already suffered PAYE & NIC.

Apart from the substantial
income tax saving, both the employer and employee will save NIC using the EBT
route.

EBTs can also be
used to assist the employee in acquiring other assets, such as a car at minimum
tax cost. If an employee is granted an interest free loan through the EBT to
purchase a car from his employer, the employee will be taxed on the loan but
this will be substantially less than the tax due on a car benefit charge.

By using the EBT in this way,
both the employer and the employer win; the employer, since he has obtained tax
relief on the contributions to the EBT and removed the burden of providing a
vehicle to the employee, and the employee because his tax liability on the car
has been removed and he has obtained a cost effective loan to purchase the
vehicle.

The rationale
behind both these strategies is that generally the tax payable on a benefit
will be substantially less than that payable on a bonus. Therefore, it makes
sense from the employee’s perspective for the assets and other forms of benefit
to be provided through the EBT.

In addition,
EBTs can be used to provide incentive-driven rewards by the use of share
schemes.

The vast
majority of EBTs are settled offshore, for example on the Isle of Man or Channel
Islands, outside the UK tax regime. It is important to note, however, that the
employer’s PAYE, NIC and benefit-in-kind reporting obligations are not affected
by the EBT’s offshore status. This reporting responsibility lapses when the
employee leaves employment even though he may still have a loan owing to the
EBT.

In making
contributions to an EBT, there are no adverse Inheritance Tax issues since the
settlement of cash into an EBT is a commercial transaction with no element of
bounty. Accordingly there cannot be any transfer of value with gratuitous
intent.

The
Verdict

Any profitable business
wishing to reward directors and employees for their efforts, would be advised
to consider using an EBT as a tool to provide those rewards.

Graham Callard LLB (Hons),
Barrister is a tax adviser at Howard Kennedy, Solicitors and can be contacted
on 020 7546 8967 or g.callard@howardkennedy.com
.

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