Briefing Note on ‘the Loan Charge’

In response to concerted pressure from MPs and lobby groups, and in fulfilment of a promise made by Boris Johnson to Parliament, the government has asked Sir Amyas Morse (former Head of the National Audit Office) to conduct a review, to be completed by November 2019, into whether the ‘Loan Charge’, “as it applies to individuals who have directly entered into disguised remuneration schemes, is an appropriate response to the tax avoidance behaviour in question”. To understand what this is all about, read on….

  1. Many relatively low-paid employees and contractors have been lured into providing their personal services to clients, including government departments, on the basis that, each year, the individual worker would receive minimum wage payments, subject to income tax and NICs under PAYE, and the balance of the consideration for their services being made up of loans – typically advanced by the trustees of an offshore trust funded directly or indirectly by the client . The loans were generally represented to be ‘open-ended’, that is, there was no expectation that the worker would be required to repay the loan for many years, if at all. (Broadly, it was anticipated that the loan would be released, free of tax, after the worker’s death.) The loan element was – so it was represented – not “earnings”, and therefore not subject to deduction of income tax and NICs under PAYE.
  2. Such arrangements were widely promoted by accountants and other tax advisers in the period from c 1993 until (at least) 2010. They were adopted by a wide range of employers/engagers, both small and large, including government departments.
  3. In many cases the legitimacy of the arrangement was represented by promoters and advisers to be in reliance upon the written Opinions of well-known Q.C.s. Whilst never formally ‘approving’ such arrangements, HMRC were slow to challenge them or respond to disclosures of their intended use or open enquiries into returns which made full disclosure of them.
  4. The practice of having third-party trustees make such loans to employees and directors was effectively stopped when, in 2011, the ‘disguised remuneration’ rules (in Part 7A, ITEPA 2003) were introduced. It is understood that Ministers insisted that this legislation be framed as imposing a charge on individual employees, rather than as a levy on the employer funding the arrangement. Similar rules relating to workers who were not employees or directors took effect from 6 April 2017.
  5. In 2017, the Supreme Court (in the “Glasgow Rangers” case) ultimately held that payments for or in respect of an employee’s services which are re-directed with the consent or acquiescence of the employee to a third party (such as trustees) nevertheless fall to be taxed as payments of earnings subject to deduction of tax and NICs under PAYE.
  6. The disguised remuneration rules did not, of themselves, bring into charge to income tax the benefit enjoyed by employees and workers of having existing pre-2011 loans remain outstanding, and employers/clients, and individual taxpayers, were showing an obvious reluctance to come forward and agree settlements with HMRC, accepting that the amounts outstanding were properly to be taxed as earnings or profits of a trade.
  7. Accordingly, the government introduced a ‘one-off’ charge to income tax (and NICs) on (broadly) the aggregate amount of loans outstanding as at 5 April 2019 (“the Loan Charge”). The charge applies to all loans made as far back as 1999 in circumstances which, if such a loan was now made, would fall within the scope of the ‘disguised remuneration’ charges introduced in relation to employees and directors, in 2011 and, for certain other workers and close company participants, in 2017.
  8. Criticism of the Loan Charge has been voiced on the basis that:

(a) It is perceived as ‘retrospective’ in effect, as it applies to loan arrangements made as far back as 1999.

However, the charge is levied on the current, ongoing, benefit to an individual of the lender failing to call for repayment of the loan, that being a benefit which accrues daily for so long as it remains unpaid. The charge did not apply in relation to a loan if it had been repaid in cash before 6 April 2019.

(b) The Loan Charge imposes an immediate charge to income tax (and NICs), on a single occasion, on amounts which represent the aggregation of income accrued over up to 20 years. A reporting obligation must be satisfied by 30 September. The tax, if not accounted for under PAYE, must be accounted for by self-assessment, with the deadline for submission of SA Returns being 31st January 2020 (and an earlier deadline of 5 October for paper returns).

Whilst HMRC has offered deferred payment terms to those individuals with gross annual earnings of less than £50,000, the burden on many individuals to fund the tax is very substantial and it has been reported that, in extreme cases, individual taxpayers have been driven to suicide as a consequence.

(c) In most cases, the burden of the charge falls on the individual, rather than upon the employer or client who, typically, stood to benefit from the arrangement as it meant that the net cost of the arrangement was reduced below that of paying earnings in cash, principally because of the saving of employers’ 13.8 % NICs.

Whilst extant employers are primarily liable to account for tax under the Loan Charge, in the case of those which have ceased to exist, or are no longer the PAYE employer, HMRC is exercising power to recover the tax directly from the individual.

(d) In reality, many individual participants benefitted only marginally, in terms of net ‘cash in hand’, as much of the perceived ‘savings’ were taken by the promoters/advisers in fees. Many lower-paid employees and contractors had little or no choice as to whether to participate in such arrangements as the employer/intermediary/client made such participation a condition of securing the paid employment/engagement.

(e) So far as many individual participants were concerned, it was represented to them that such arrangements were ‘legitimate’ and ‘acceptable’ to HMRC, and this understanding was reinforced by the fact that HMRC did not in fact challenge such arrangements even when the full circumstances were disclosed to them, either by way of formal ‘up-front’ ‘disclosures [by the promoters] of a tax avoidance scheme’, or in response to enquiries opened into an individual’s self-assessment return.

(f) Those who in fact gained most from such arrangements (as implemented in relation to relatively low-paid workers), namely the promoters and advisers, have effectively avoided sanctions. It is not possible, under existing laws, for HMRC to secure recovery, from the promoter/adviser, of the tax now due from an individual participant.

(g) Whilst HMRC has, until recently, offered, to both employers and individuals, ‘settlement opportunities’ which would allow an individual to avoid the Loan Charge by the employer or employee agreeing to account for tax on the loans as if they were earnings of the relevant years, the tactics used by HMRC to ‘persuade’ taxpayers – particularly individuals – to reach settlement agreements have been strongly criticised as “strong-armed”.


David Pett, Temple Tax Chambers                                                            11 September 2019

In Defence of the ‘Outstanding Loan’ Charge

The former Financial Secretary to the Treasury recently announced in a letter to MPs that “HMRC will not apply the Loan Charge to a tax year where (sic) an enquiry was closed on the basis of fully disclosed information.” I venture to suggest that this is misguided, both as a matter of law and as a matter of social policy.

There are two economic benefits of a loan enjoyed by the person to whom it is made:

(a) the value of the loan in the sense that the price being paid for it (in terms of the interest rate payable) is less than the market value of such credit on the same terms. One measure of this is the difference between the amount of interest actually paid, and the rate at which it would have been charged if the loan had been made on arm’s length/open-market terms. In the case of an employment-related loan the amount of such benefit is (broadly) charged to income tax by reference to the Official Rate of interest; and

(b) if it is not a ‘fixed term’ loan, that of the continuing forbearance of the lender in not calling for immediate repayment.

The latter is not taxed as ‘general earnings’ (under the benefits code) of the borrower, but there is no reason in law why Parliament should not have determined that such an ongoing benefit is properly to be the subject of a charge to income tax in much the same way that other profits or gains not obviously income in nature (such as, e.g. share option gains) have been brought within the charge to income tax, regardless of whether the loan was linked to an employment or a self-employed trading activity. This is, in effect, what Parliament has done in legislating to impose the Loan Charge as at 5 April 2019. The fact that the loan was made pursuant to arrangements made as far back as 1999 has no bearing on the fact that, if the loan has not been repaid, a benefit is still being enjoyed on a current daily basis.

It is said that it is wrong in principle, and/or as a matter of law, that a taxpayer should be at risk of a charge to tax on the benefit of an arrangement made many years ago and which was fully disclosed to HMRC in, or in respect of, the tax year in which it was entered into and which HMRC chose, for whatever reason, not to challenge. The existing legislation provides a balance between the obligations of a taxpayer to self-assess his or her income and gains, and the statutory time limits on HMRC’s power to enquire into a return or make a discovery. It is important that the courts uphold this balance, and they do so (see, for example, the recent decision of the Court of Appeal in Tooth v HMRC [2019] EWCA Civ 826). But the point is that income tax is charged on an annual basis and the need to maintain that balance in relation to historic earnings or benefits cannot be taken to restrict Parliament from deciding to impose a charge to tax on what is, in effect, a continuing current benefit enjoyed from day to day for so long as a creditor chooses not to call for immediate repayment of an open-ended loan.

The passage quoted above suggests that those individuals (typically contractors, not employees) who are continuing to enjoy the ongoing benefit of not having to repay loans made to them in lieu of payments of taxable income may avoid the Loan Charge if an enquiry was opened into their tax affairs in respect of the year in which the loan was made, or possibly a later year, and since closed, and the existence of the loan was then fully disclosed but not challenged by HMRC. By contrast, those who were not the subject of such an enquiry will not avoid the Loan Charge. If correct, this will mean that individuals who continue to benefit from outstanding unpaid loans will now be taxed differently according to whether or not HMRC happened to have opened, and since closed, an enquiry in respect of an earlier year. Looked at from the point of view of the millions of taxpayers who have not enjoyed the benefit of receiving profits of their employment or trading activities in the form of loans, this would surely be seen as unfair discrimination in favour of those who have ‘shouted loudest’ yet benefitted at the expense of all other taxpayers.

It is certainly the case that HMRC should have acted sooner to put an end to the egregious tax planning arrangements and to the activities of those advisers who promoted such structures and profited handsomely from doing so. Ministers are properly to be criticised for having failed to do so. There was a strong case for action to have been taken long before 2011 to impose charges to tax on such loans as if they were earnings, or, as appropriate, trading income, of the recipients and taxed accordingly – in the case of employees, by imposing the charge primarily upon the employer, not the employee. The decision of the Supreme Court in the Glasgow Rangers’ case was too late in the day to stop the use of EBT loan arrangements.

It was asserted that, at least in relation to employment-related arrangements, if (per the Supreme Court in Glasgow Rangers) contributions to the trust which made the loans were properly to be taxed as income of the employee at that time, no further charge should arise on the basis that the loan by the trustee was merely an application of the employee’s earnings. The government moved to head off such arguments by making clear, in what is now s554A (5A) to(5C) ITEPA 2003, that the use of such ‘re-directed earnings’ does not obviate the application of the disguised remuneration rules (including the Loan Charge) to loans made out of such taxable earnings. (The Loan Charge applies in relation to individuals who are not employees by reason of the arrangements having fallen within s 23A ITTOIA 2005 and Schedule 12 F(No.2)A 2017.) In any event, the idea that HMRC is entitled to challenge a loan arrangement only within a limited period after the tax year in which it was entered into ignores the fact that, for so long as the loan remains outstanding, that arrangement in itself affords a distinct and ongoing benefit which is a legitimate target of the government in seeking to ensure that all taxpayers are dealt with fairly.

How Far Will the Courts Go to Rectify a Tax Statute?

Once upon a time, taxpayers and their advisers could take at face value the wording of a tax statute and ensure with certainty that matters were within, or outside, the clear words of a charging provision. It is, after all, widely accepted that “a subject is only to be taxed on clear words, not on any ‘intendment’ or on the ‘equity’ of an Act” (per Lord Wilberforce in WT Ramsay v IRC [1982] AC 300 (known as ‘the clear words principle’).  So, if the wording is clear, the taxpayer is at liberty to ‘work around’ it, or so arrange matters as to fall within an exemption, or outside a charge, as he or she pleases.  If the clear words produce an unintended effect, that should surely be recognised as the ‘fault’ or consequence of the efforts of the legislative draftsman or of Parliament. Not now, it seems. If the clear words allow taxpayers to frustrate what the courts infer to be the presumed policy intent of the legislation, the courts will readily seek to apply an interpretation which rectifies the shortcoming in the drafting and imposes a charge in the manner in which it is presumed to have been intended. How far can the courts be expected to go in presuming to rectify the faults of Parliament?

In the UBS/Deutsche Bank case (UBS AG and Deutsche Bank Group Services (UK) Ltd v HMRC [2016] UKSC 13), which came before the Supreme Court in 2016, the court was required to consider if the deliberately constructed rights of securities in a special-purpose company meant that the securities were, or were not, “restricted securities”. The statutory definition of a security which is “restricted” (in s 423 ITEPA 2003 (as amended)) is clear and unambiguous. The terms of the securities in question were carefully crafted so that they fell within that definition and would therefore be exempt from tax on acquisition. If they were so restricted (by being subject to a short-term risk of forfeiture), the taxpayer companies would have succeeded in avoiding many millions of PAYE tax on bankers’ bonuses. However, the Court held that the reference, in s423, to “any contract agreement, arrangement or condition which makes provision to which any of ss(2) to (4) applies” is properly to be construed as being limited to provision having a business or commercial purpose, and not to commercially irrelevant conditions whose only purpose is the obtaining of the exemption, notwithstanding that the legislation makes no reference to such a requirement. The court took it upon itself to presume an intention of Parliament, namely that securities will not be taken to fall within the clear and prescriptive definition in the statute if taxpayers would thereby succeed in gaining exemption from tax notwithstanding a lack of commercial purpose. Of course, had the provisions included, as a requirement for such exemption, a ‘purpose test’, the need to have imposed this extra-statutory requirement would not have arisen. Parliament was surely at fault for having failed to do so.

It had been hoped (by the author, at least) that this was the ‘high water-mark’ of moves by the judiciary to correct errors in, or seek to avoid unintended consequences of, the drafting of tax statutes. Surely, if Parliament fails to ‘cover all bases’, the citizen is  – and, in a democracy governed by the rule of law, should be – at liberty to order his or her affairs so as to conform to the letter of the law, albeit with a consequence which might be widely regarded as egregious, selfish and anti-social. Not so, it seems.

The recent judgement of the Supreme Court in Hancock v HMRC ([2019] UKSC 24) is a further example of the court making every effort to avoid taxpayers enjoying the benefit of having relied upon the most obvious interpretation of what are, in this case, clear words in the Taxation of Chargeable Gains Act 1992 (“TCGA”). Here, the taxpayers had taken advantage of the fact that s116(1)(b) TCGA 1992 (which, if it applied meant that a conversion of securities into other securities would qualify for ‘rollover relief’ and therefore defer, but on a later disposal result in, a charge to tax) makes clear reference to two situations: where the original shares consist of or include a QCB and the new holding would not; or where the original shares would not and the new holding would consist of or include a QCB. In the appellant’s situation (deliberately engineered), the original shares included QCBs and the new holding into which they were converted was solely of QCBs, so – it was argued – neither limb of s116(1)(b) applied and, in consequence, the later disposal of the new holding of QCBs should have been exempt from CGT by reason of s115 TCGA 1992.

One response to such an opportunistic move by the taxpayers could have been for HMRC to accept that there is a lacuna in the drafting of TCGA 1992 and arrange for it to be rectified at the next available opportunity to do so, leaving the taxpayers to deal with the opprobrium to be heaped upon them for successfully avoiding tax.

Should government and the courts not accept that such shortcomings are the responsibility of Parliament to correct, not for the justices to do so? As Lady Arden has demonstrated, that is not the view of the Supreme Court: “…the Appellants’ interpretation result would be inexplicable in terms of the policy expressed in these provisions, which is to enable all relevant reorganisations to benefit from the same rollover relief [and not for some only to be treated differently so as to enable a subsequent disposal to be treated as exempt from CGT]”.

To ensure the taxpayers were liable for tax on the gain realised by them, Lady Arden adopted the reasoning of the Court of Appeal that “it is clear that the intention of Parliament was that each security converted into a QCB should be viewed as a separate conversion (which amounts to the same thing as regarding the conversion…as consisting of two conversions, one of QCBs and one of non QCBs).” On that basis, the taxpayers triggered a chargeable gain when the rolled-over securities were disposed of. Further, and because s132 states that sections 127-131 shall apply “with any necessary adaptations” to conversions as they apply in relation to a reorganisation (i.e. providing for there to be a ‘rollover’ not involving a disposal, with the new securities being treated as the same asset acquired as the old securities were acquired), the ‘clear words principle’ was, in Lady Arden’s judgement, observed.

This is subtly different from applying the principle in Luke v IRC [1963] AC 557. That enables a court to adopt a “strained interpretation [of a statute] in place of one which would be contrary to the clear intention of Parliament, although this is limited to, for example, situations in which there is not simply some inconsistency with evident parliamentary intention but some clear contradiction with it – and the intention must be clearly found in the wording of the legislation”.

Of course, and with due respect to her ladyship, in the absence of an express statement of policy in the statute itself (which is not something normally to be found in a taxing statute – perhaps the nearest one comes to a declaration of intent is, for example, s527 ITEPA in relation to EMI options), the policy intention of HMRC and/or Parliament can only ever be inferred from the effect of the words of the Act. Drawing such an inference inevitably involves an element of subjective judgement as to which informed judges may, not unreasonably, differ in their opinions. This is surely what underlay the ‘clear words principle’ – that, and the broader notion that the citizen should not be deprived of his assets without Parliament having clearly stated the basis on which it is to be done.

If, had the appellants in Hancock been correct, the way would have been opened for relatively easy tax avoidance, the answer is surely that this is the price worth paying for ensuring that the citizen is only deprived of his wealth by the clearly expressed will of Parliament – not by what a court might infer to be the broad intention of Parliament (rather than that of HMRC and/or government) which, if the provisions were not fully debated, may not be clear.

When Is a Share, or Share Option, “Employment-Related” so as to Come Within the Scope of the Charging Provisions of Part 7, ITEPA 2003?

It has long been understood that the charges to income tax on employment-related securities apply to shares, or a share option, acquired by a person if the right or opportunity to do so is available “by reason of” an office or employment (see ss421B(1) and 471(1) ITEPA). However, when re-enacted in 2003, the legislation further extended the scope of Part 7 by providing that a right or opportunity to acquire shares, or options, is deemed to be available by reason of an office or employment if it is made available by a person’s employer or by a person connected with a person’s employer (e.g. another company in the same group). These ‘deeming provisions’, in ss421B(3) and 471(3), are not easy to interpret and apply, not least because the definition of “employer” – which refers to the (office or) employment  by reason of which the opportunity is available – appears to produce a circular analysis.

As Charles Hellier pointed out in his decision in Steven Price ([2013] UKFTT 297 (TC)), the sections cannot be construed literally, as that would mean that shares or options acquired pursuant to an opportunity made available to an individual by someone who happened to be an employer of another person,  would be caught by the deeming provisions, and that is absurd.

If the answer is that, for the deeming provisions to apply, the provision by a company of an opportunity under which the shares or options are acquired must be linked to an office or employment by the individual with the same , or a connected company, then this would appear to be no different from the test of whether the shares or options have been acquired pursuant to an opportunity made available “by reason of” an employment. Further, if Parliament had intended that an option granted to a person who is, or has been, an officer or employee, is invariably to be treated as an employment-related securities option (regardless of the fact that it is not ‘by reason of such office or employment’), the legislation would simply have said so. But it does not.

Of course, if the opportunity was in fact made available by a person or persons other than the company with which the individual has an office or employment (or a connected company), the deeming provisions cannot apply. So, if for example, on investigation, it is the shareholders, or one or more of them, who make the opportunity available, not the company itself, then, provided the acquisition is not “by reason of” an office or employment, the shares or options will fall outside the scope of Part 7.

A recent decision by Dr Heidi Poon (best known for having delivered the minority judgement in the Glasgow Rangers case in the First Tier Tribunal – ultimately substantially upheld by the Supreme Court) in the case of Vermilion Holdings Ltd v HMRC ([2019] UKFTT 0203 (TC)) has looked again at the scope of these deeming provisions. An individual investor held options to subscribe for shares in the company. He subsequently became a director and, in his capacity as an investor, was party to the negotiation of a reconstruction and refinancing deemed necessary to save the business of the company. In short, in was decided that his option terms should be amended so as to reduce his proportional entitlement on exercise of the option, relative to that of other investors (including himself). Rather than amend the terms of the existing option, it was decided, for commercial reasons, to cancel the original option and grant a fresh option on new terms. The new option was clearly not granted “by reason of employment”, but as it was granted by the company of which the individual was then a director, HMRC asserted that the deeming provision of s471(3) applied. Clearly it would be unfair if the individual were, in this situation, to find himself chargeable to income tax and NICs, rather than capital gains tax as would be the case with any other investor in the same position who happened not to be a director.

At the end of a long judgement, Dr Poon holds in favour of the company (the appeal having been brought by the company in response to a Reg 80 determination in relation to the PAYE income tax and a s8 decision in relation to the associated NICs), apparently on the basis that “[the individual’s] right to acquire the 2007 option was not ‘made available’ by Vermilion as his ‘employer’” (para 141). Expressed in these terms, the decision is clear and straightforward – and hardly justifies some 15+ pages of analysis. However, I say “apparently”, as this is stated to be an alternative ground: the principal ground being that “The ambit of the deeming provision should be limited where the artificial assumption is at variance with the factual reason that gave rise to the right to acquire the option” (para 140). This leads us into difficult territory, suggesting as it does that, even if the opportunity to acquire the option is provided by the company, the deeming provision does not apply if  (a) that right or opportunity was not available by reason of the individual’s office or employment and (b) the acquisition was not pursuant to an opportunity which was so available.

Charles Hellier earlier gave the example of a bank offering options to all customers, some of whom are employees of the bank. He suggested the need for an investigation in such cases into whether a link exists between the employment and the opportunity. If the opportunity under which an option is acquired is not the same as the opportunity offered to an employee, the deeming provision does not apply. This may work if the opportunity is afforded to a number of individuals, some only of whom happen to be employees or directors, but the position is not so clear if the opportunity is offered to only a single individual who happens to be an employee or director. Can the link with the office or employment be so easily broken?

What if (for example) an employed shareholder is given the opportunity to acquire shares made available by operation of the articles of association requiring a leaver to offer their shares for sale to all remaining shareholders on a pro-rata basis? If an opportunity to acquire shares is offered to all shareholders, only some of whom are directors or employees, it is easy to see that the opportunity is acquired qua shareholder and that there is no link between the acquisition of the shares and an individual’s office or employment with the company. Here, the “artificial assumption”, that the acquisition is by reason of employment, is at variance with the factual reason which gave rise to the right or opportunity to acquire the shares.

However, the opportunity to acquire the shares is made available by the employer (through the operation of its articles), and prima facie therefore the deeming provisions would appear to apply. Put another way, if they are not to apply in such a case, Parliament’s presumed intention of extending the scope of Part 7 may be rendered ineffective.

That said, the decisions in both Steven Price and Vermilion would appear to support the conclusion that the deeming provisions do not apply if:

  • the opportunity to make the acquisition is not by reason of an office or employment; and
  • although that opportunity is made available by the employer company, there is no causal link between the acquisition of the shares or option and the office or employment held by the individual.

The difficulty remains that, if the deeming provisions are not to apply in relation to such an acquisition by a director or employee, in what circumstances are they intended to apply? When is an acquisition from the employer made pursuant to an opportunity afforded by the employer which is not by reason of that office or employment, but is linked to the office or employment with that employer (so as to fall within the deeming)?

We are left in a situation in which unless, as in Vermilion, the opportunity to acquire shares or an option is not in fact made available by the employer of the individual concerned, the scope and application of the deeming provisions remains unclear.


5 May 2019

The ‘Loan Charge’ has Bitten: So What Now?

The ‘loan charge’ has taken effect today. Those beneficiaries of ‘EBT loan schemes’ who have by now failed to settle, or at least register with HMRC their willingness to agree to settle, all unpaid liabilities to income tax, NICs and, if appropriate, inheritance tax arising from re-directed earnings and earlier ‘disguised remuneration’ charges (on, for example, any post 5th April 2011 earmarking and/or making of a loan) must now take action to ensure that income tax and NICs are properly accounted for.

Unless, before 5 April 2019 the client and/or the employer company (a) registered with HMRC a clear intention to settle all related earlier tax liabilities and (b) provided all relevant information to HMRC, the employer company is liable to account for the tax and NICs on the amount of any loans and ‘quasi-loans’ outstanding (or deemed to be outstanding) by 19th April (by post) or 22 April (online) and to report the loan charge amount to HMRC via RTI in April 2019 using an Earlier Year Update submission (available from 20 April 2019). The relevant individual is also be obliged to deliver to HMRC an information return by 30 September 2019.

This information requirement, and a description of the rules affording a degree of mitigation against double taxation which apply when determining the amount of tax payable upon the loan charge and when subsequent ‘relevant steps’ are taken within the scope of the ‘disguised remuneration’ rules, are the subject of my article published in Tax Journal on 5th April 2019. See:

[Note, if you do not subscribe to Tax Journal, I shall be permitted to reproduce the article as from Sunday 14th April.]


Employee Share Ownership at its Best – The Xtrac Story

At a reception following the ESOP Centre’s British Symposium on 7th March 2019, I had the privilege of accepting, on behalf of Xtrac Limited, the 2018 award for the ‘Best All-Employee Share Plan in a Smaller Company’ in recognition of that company’s efforts and achievements in promoting share ownership amongst all its employees. Since it was founded in 1984, the company has over the years received many awards for its success in the design and manufacture of high-precision gearboxes and powertrains for Formula 1 and other motorsports, an industry in which it is a world leader. In 1997 its founder, Mike Endean, retired and sold the company to its management and an employees’ trust. Since then, the company has grown, from around 100, to currently over 360 employees and apprentices and a turnover in the region of £50 million. Its state-of-the-art factory and design facility in Thatcham opened in 2000, and a major extension was recently inaugurated by the Prime Minister, Theresa May. Although now substantially owned by a private-equity fund, the company is a shining example of how a policy of positively encouraging employee share-ownership has contributed to the group’s success and positive employee engagement.

Xtrac is, perhaps, unique in having, since 1997 and whenever possible having regard to its ownership structure from time to time, made use of every recognised type of employee share scheme. For so long as it was ‘independent’, Xtrac operated a (pre-2000) ‘Inland Revenue-approved profit-sharing scheme’, as well as Inland Revenue-approved ‘savings-related’ and ‘company share option (“CSOP”) schemes’. Following the introduction of “Share incentive Plans” (“SIPs”) in 2000, the company has established a series of such plans under which shares have been regularly awarded as ‘free’ shares as well as, on occasions, having also been offered for purchase out of pre-tax earnings (i.e. gross earnings before tax) as ‘partnership shares’. Some employees have, in the past, benefitted from EMI (“enterprise management incentive”) and ‘unapproved’ share options, as well as joint share ownership arrangements and so-called ‘growth shares’. Crucially, perhaps, participating employees have been afforded opportunities to realise the value of their shares, to which they have contributed by their labours, both when they retire from service and on the occasions when investment by third party private equity funds, and the inevitable corporate reorganisation, has afforded the opportunity for employees to do so. This has, in many cases, allowed employees to realise relatively substantial capital amounts, either in a single lump sum or, as appropriate, through a series of payments over time. Consequently, employees have recognised and enjoyed additional benefits in working at Xtrac when compared with the more limited opportunities for financial participation in other companies. Even after the most recent change of ownership of the group in 2018, participating employees remain holding financial interests through loan notes held, for the most part, within the tax-free envelope of the SIPs under which shares were first awarded.

Share scheme advisers may be interested in the fact that, unusually, the Xtrac Employees’ Trust first established in 1997, and used to warehouse shares, award them pursuant to SIPs, and transfer them in satisfaction of share options, as well as buy-back or receive shares sold or forfeited by leavers, is a UK – not an overseas-based – trust. The trustee is a single corporate trustee (a company with a share capital) which is wholly-owned by what is now an intermediate holding company within the Xtrac group. Its directors include both employees’ representatives and an individual (me!) who has only a non-beneficial interest in the financial success of the group. At all times, the Xtrac share schemes, including the SIPs, have been self-administered by an officer of the company without the need to engage third-party plan administrators. Although the company’s use of tax-favoured schemes has over the years thrown up a number of technical issues exploring the scope and application of the tax legislation, it is fair to say that all of the arrangements made by the company to take full advantage of available tax reliefs have operated as intended by government and HMRC and, accordingly, the recognition accorded by the ESOP Centre award is well deserved. Xtrac is an example to others of how, used appropriately, employee share ownership benefits the company itself and all its shareholders. Congratulations to Xtrac.

Inheritance Taxes and Employees’ Trusts: A Need for Change?

The period for consultation in response to “The Taxation of Trusts: A Review”, published by HMRC on 7 November 2018, ended at the end of February 2019. The Share Plan Lawyers’ Group has taken the opportunity to submit a number of suggestions for change in the light of practical experiences in the application of the legislative provisions to employees’ trusts established for normal commercial purposes, rather than as part of a tax avoidance scheme.

1. The requirements of s86 IhTA have long been ‘honoured in the breach’ and there is a need for it to be recast so as to make clear that a discretionary settlement for a class comprising bona fide employees (including ‘workers’) of any company which is from time to time a member of the 51% group of companies of which the settlor company is the parent, will be a ‘s86 trust’. This should be regardless of whether the employer company carries on a “trade or profession or undertaking”, or of the fact that different members of the same group might carry on disparate trades or undertakings. This should be an additional test which, if satisfied, means that s86 may be taken to be satisfied. Put another way, a trust for employees of a group of companies of which the settlor is the ultimate parent, should satisfy the gateway requirements of s86 regardless of the activities of that group or of any particular employer member of it.

Corresponding and consequential amendments would be needed to ss28 (so as to add wording similar to that in ss13(1)(b)) and 75 so as ensure a consistent approach.

2. There is a strong case for allowing an employees’ trust intended to satisfy s86 to be drafted in a manner which allows for the interposition of a new holding company (with no substantial change of ultimate ownership) so that, thereafter, the class of beneficiaries may be taken to include (also) employees of the new holding company – allowing for a hive-up of the business and a continuity of the use of the trust. The existing position is that if such a new holding company is interposed, and the trade hived-up, the old holding company must be kept in existence solely for the purposes of ensuring that the trust may be applied to benefit (existing, but not new) employees of the hived-up trade and/or employees of other subsidiaries of what was the old group holding company. If the old holding company is wound up, there will then be no employee of that company or of any former “subsidiary” of that company. Keeping in place the old holding company in this situation is an unnecessary administrative burden.

3. In s13, sub-sections (4)(a) should be amended so as to make clear that a power to apply the trust fund in the provision any benefit paid out to, or for the benefit of, a beneficiary which gives rise to a charge to income tax on the part of that beneficiary as either a general earnings charge, or under Parts 7 and/or 7A of ITEPA will not mean that the requirements of s13 are not satisfied. Whilst HMRC appear to accept that a power to make a payment which gives rise to a charge to income tax, such as a one-off transfer of shares, is within ss(4)(a), the exemption in that sub-section could be read as applying only to payments which, as a matter of general law, are in the nature of income, as opposed to payments of a capital nature (e.g. an award of shares) which happen to be brought into charge to income tax under specific legislative provisions. Such a clarification would allow the larger close companies to make contributions without fear of triggering s94 charges where the purpose is to allow the trust to satisfy contingent share awards and L-TIP awards.

4. Sections 72 (transfers out of a s86 trust) and s65 (transfers out of a non-s86 trust) need to be amended so as to make clear that both a transfer of shares and the grant of an employment-related securities option in circumstances in which (a) a charge to income tax arises either as a general earnings charge or under Parts 7A or 7; or (b) s425(2) applies to the acquisition; or (c) the option is acquired by a member of the class of beneficiaries and s 475(1) applies to the acquisition (i.e. adopt the wording of the DR exclusion in s554N(1) and(2)). In other words, it should be made clear that the grant of a discounted option, or transfer of shares at an undervalue, does not trigger an ‘exit charge’.

5. Is there a case for seeking an exemption from inheritance tax for a gift of shares into a s86/s13 employees’ trust by an individual shareholder which is less than a controlling interest? Why should a minority shareholder wishing to gift or bequeath shares to an employees’ trust should not do so without having to rely on the availability of BPR?

Capital Gains Tax issues
6. There is a need for s239ZA to be amended so as to secure that no chargeable gain arises to the trustees upon a transfer of shares to an employee whether or not he or she gives any amount of consideration for the shares, and whether or not he or she is an ‘excluded participator’.

The principal reason why employees’ trusts are established offshore is the fact that onshore trustees remain at risk of charges to CGT if, for example, an employee purchases shares from the trust at an undervalue. Such a disposal by an offshore employees’ trust is normally outside the scope of UK capital gains tax. It is difficult to see any reason of policy why the tax treatment of onshore and offshore trustees should not be put onto a ‘level playing field’ so as to at least avoid the existing positive discrimination in favour of going offshore. Removing the justification for establishing an employees’ trust offshore would significantly reduce the cost to UK companies, and simplify the process, of using an employees’ trust to warehouse shares intended to be used to satisfy employee share awards and options.

Income tax: dividend income
7. Whilst it is a term of most employees’ trusts that dividends are waived on shares held, employees to whom deferred share awards and options are granted being paid corporation tax-deductible bonuses in lieu of dividends paid in the award period, that is not always the case. If dividend income is not waived, it is suggested that there should be both (a) an exemption from income tax, in the hands of the trustees of an employees’ trust if such dividend income on shares in the employer company (or its holding company) is distributed within, say, 3 months of receipt, on an ‘all-employee’ basis to qualifying employees and former employees; and (b) a legislative provision that such distributions be treated for all tax purposes as dividend income of the employee recipients.

This would be ‘self-policing’ in that the extent of the relief afforded is dependent upon the availability of distributable profits and the size of the trust’s holding of shares. To prevent abuse, it would need to be provided that this favourable treatment is only available if (a) the shares are in the ultimate group holding company and not in a company under the control of another body corporate; and (b) if the company has more than one class of ordinary shares in issue, the shares held by the trust are of the largest class in issue and do not have any rights or restrictions which are less favourable to the holder than those attaching to any other class of share.

It is suggested that, at the very least, Extra-Statutory Concession B18 should be enacted so as to allow non-UK trusts in receipt of UK dividend income which is distributed to UK employees, to reduce their liability to UK tax by reference to PAYE income tax paid, in much the same way that UK trusts are presently able to do under s496B Income Tax Act 2007. Under existing practice, a UK beneficiary of an offshore trust may, under ESC B18, make a claim to secure a credit for tax paid by the offshore trustee, but this is simply not practicable in many cases.

Tax-favoured plans (SIPs, SAYE, CSOP and EMI)
8. A company under the control of an employees’ trust with a single corporate trustee cannot (unless, exceptionally it is an “employee-ownership trust” of the type mentioned in s326H et seq TCGA 1992) make awards or grant options under such tax-favoured plans (because, although the company is not a 51% subsidiary of another body corporate – the trustee – , it will still be under the control of that other body corporate). By contrast, if the trustees were individuals or two or more unconnected trustee companies, the company could do so (if all other requirements are satisfied). It cannot have been intended, as a matter of policy, that the ability to take advantage of such tax-favoured schemes would depend upon the identity of the trustee(s).

It is therefore suggested that a company which is (i) under the control of a single corporate trustee (which, in its capacity as trustee, is not itself a 51% subsidiary) of an employees’ trust, and (ii) not under the control of any other person or persons, should be treated as ‘independent’ for these purposes so as to allow access to such tax-favoured schemes.


March 2019

Finance Bill Changes to Entrepreneurs’ Relief

The government has listened: further changes to Entrepreneurs’ Relief from CGT are announced

Following representations by a number of professional bodies, the government has (on 21st December 2018) tabled amendments to the Finance (No.3) Bill currently before Parliament so as to address many of the concerns raised that the changes proposed to be enacted following the 2018 Budget went far beyond what was required to achieve the policy intent and would have had the effect of denying the relief in those cases in which the company has more than one class of share in issue and/or the individual had no entitlement to dividends on the class of shares held.

The further measures tabled on 21 December 2018 include changes to paragraph 2 of Schedule 15 of the Finance Bill, which contains the changes to the definition of ‘personal company’ for ER purposes. These amendments add a test based on the shareholder’s entitlement to at least 5% of the proceeds in the event of a sale of the whole of the ordinary share capital in the company. This test can be used instead of those based on having an entitlement to at least 5% of both (i) the profits available for distribution and (ii) assets on a winding up. Those tests remain “to provide certainty to those with straightforward company structures”, but the new alternative test will help those who, for commercial reasons, are not able to meet the original tests. It does not rely on the definitions in the Corporation Tax Act 2010.

This provides welcome relief to many shareholders in companies with standard form articles which, for example, do not give a clear entitlement to a pro rata amount of any dividends declared.

Other changes make clear that the new alternative test is to be applied as at the last day of the period throughout which the company is required to have been the individual’s “personal company” (i.e. typically, on a sale of the company, at the time of that disposal). In determining if a company is an individual’s “personal company” by reason of the individual satisfying the new alternative test, it is to be assumed that the company is sold for its market value and that, having regard to all the circumstances, the individual is then beneficially entitled to that to which it would be reasonable to expect the person to be beneficially entitled. For this purpose, any tax avoidance arrangements are to be ignored.

January 2019

Labour’s ‘inclusive ownership funds’: is there a more sensible structure?

The Labour Party has proposed that all companies with more than 250 employees should, over a 10-year period, put up to 10% of their share capital into an employees’ trust. Of the dividends paid on such shares, employees would benefit from tax-free distributions of up to £500 per year, with the balance going to the government by way of a hidden form of advance corporation tax. This idea has met with derision from many companies and advisers – and rightly so.

Yet hidden within that proposal lies the seed of a perfectly good idea which might be of real attraction to many companies of whatever size.

A more balanced proposal?

I refer to the concept – first put forward  in the context of ‘employee-ownership trusts’ (see earlier posts) – that dividends on collectively-held shares in a company could be paid out to qualifying employees, on an ‘all-employee/similar terms’ basis, and that, provided such dividend income of the trust was so distributed to employees within a period of, say, 3 months of receipt:

  • it would be exempted from tax in the hands of the trustees; and
  • fall to be taxed as dividend, not earned, income in the hands of the employees.

Such an arrangement would be voluntary and, to an extent, ‘self-policing’ in the sense that, if there were no profits, there could be no dividends. Likewise, to the extent that all shareholders are paid dividends, so too would the employees – without individual employees needing to buy, or pay tax on the acquisition of, an actual holding of shares. The £2,000 dividend tax exemption would mean that most employees would not pay tax, and if, exceptionally, the individual distributions exceed that sum, it is surely fair and reasonable that tax (but not NICs) is paid on the amount of the excess at the employee’s marginal rate.

The shares in question would need to be of the same class as that held by the majority or controlling shareholders or, at least, have rights to receive payment of any dividends which are no less favourable than those attaching to any other class of share in issue.

To qualify for such favourable tax treatment there might be a threshold percentage level of shareholding which must be so held collectively – but this could equally be left to the determination of existing shareholders. Such a collective holding – through a trust – would also afford the opportunity for the votes attaching to such holding of shares to be cast by the trustees in a manner which they determine to be “in the best interests of employees”, and for the company to establish a corporate governance structure for the selection and appointment of trustees. That said, perhaps the principal objective of the collective ownership of shares would be best served by allowing any voting rights on such shares to be restricted or suspended.

Provision would be needed to address the question of how the proceeds of sale of the collective holding should be applied if the company were sold. This is a conundrum facing The John Lewis Partnership and other such ‘employee-owned companies’ (being not in fact ‘owned’ by individual employees): who ultimately derives benefit from the growth in capital value of such shares? It would surely be unfair for only those in employment at that time to derive such growth. If the idea is merely to encourage dividend distributions to employees, the shares so held could perhaps be redeemable at par, or for a nominal sum, in the event of a sale of the company, so that capital value is retained by other shareholders.

This is merely the seed of an idea. It will be interesting to see if the Conservative government might germinate it into a fully-developed structure for enabling employees (as opposed to the government) to share in annual profit and thereby afford incentive to work for the success of all shareholders.

30 September 2018

Trustees of employees’ trusts: are you doing enough in response to the upcoming “outstanding loan charge” to income tax and NICs?

Given the forthcoming “outstanding loan charge” to income tax under the Disguised Remuneration rules, trustees of all forms of employee trusts should, by now, have taken steps to identify any and all loans, quasi-loans, and other forms of credit extended to employees, or to any person nominated by an employee (past or present) or any person linked with an employee (“a relevant person”) outstanding made at any time after 5 April 1999 and outstanding at any time on or after 17 March 2016.

The one-off, and penal, charge to income tax and NICs on “outstanding loans” will have effect on 5 April 2019 (or possibly later in the case of certain fixed-term loans). The scope of the charge is broader than many have assumed. In some cases, for example, it could apply notwithstanding that the indebtedness has been repaid, or the loan written-off, before 5 April 2019 but since 17 March 2016.

Penalties for failure to provide information to HMRC

If a loan or quasi-loan has been made to a relevant person on or after 6 April 1999 and any amount is, or is deemed to be, outstanding at any time between 17 March 2016 and 5 April 2019, the employee and the lender or creditor are each obliged to provide to the employer, within 10 days after the loan charge date, all the information necessary for the employer to comply with its PAYE obligations. If, having taken reasonable steps, the employee and lender have failed to contact the employer to provide the information, each is responsible for notifying HMRC of that fact in the form specified by HMRC (para 36, Sched 11). There are penalties for a failure on the part of trustees to comply with this obligation.

Avoiding the ‘outstanding loan charge’ by settlement

Of course, the outstanding loan charge will not arise if settlement of all previous tax liabilities (including inheritance tax charges, if applicable) have been agreed with HMRC, and the tax has been paid in full pursuant to HMRC’s settlement arrangements ( as to which, see ), but it is apparent that not all employers who made use of ‘disguised remuneration’ arrangements, or the employees concerned, have yet registered their interest in settlement with HMRC. There is a deadline, of 30th September 2018, for providing all information to HMRC if settlement is to be reached before the penal charge arises on 5 April 2019.

HMRC are willing to agree 5-year payment terms for those employees with expected annual taxable income of less than £50,000, and flexible payment arrangements for those who are in genuine financial difficulty.

As part of the settlement, consideration needs to be given to how an outstanding loan is to be released or written-off and the employee put in the economic position he expects to be in once all taxes have been paid on what he or she will then regard as ‘their money’. Trustees need to consider both their obligations as trustees needing to comply with the terms of the trust deed (etc.), and the interests of the beneficiaries in winding-up the arrangements in a cost-effective manner.

There will also need to be a focus upon the terms of the trust deed (etc.) insofar as they might provide for the cost of NICs to be borne out of the trust fund, as this can reduce the costs of a settlement.

Exemptions from the ‘outstanding loan charge’

There are limited exclusions from the outstanding loan charge although none of these applies if there is a connection with tax avoidance. They relate to:

(a) certain loans made on ordinary commercial terms if similar loans were made available to members of the public at large;

(b) if an employer has made an employment-related loan below the £10,000 threshold (in s 180 ITEPA), the employee’s employment has been transferred and the employer would otherwise be treated as having made a quasi-loan by acquiring a right to repayment of the outstanding loan;

(c) subject to conditions, loans by a bank (or similar) to its employees as part of a package of benefit generally available to its employees;

(d) subject to conditions, a loan by an authorised lender made to an employee under an employee car purchase scheme;

(e) certain loans made before 9 December 2010 to enable the acquisition, within a year, of unlisted shares in the employer company or another company in the same 75% group, although an outstanding loan charge may still arise if the loan remains outstanding 12 months after the shares cease to be held by the employee.