Nichola Ross Martin's Tax Consultancy

An EFRBS (or EFURB) is a unapproved pension scheme. This means that it does not share quite the same tax advantages of a conventional occupational pension scheme.

Latest news
Anti-avoidance legislation is being introduced in the 2011 Finance Bill to ensure that tax on employment income is not avoided or deferred through the use of trusts or other intermediaries, such as Employee Benefit Trusts (EBTs) and EFRBS. Anti-forestalling rules apply from 9 December 2010. It is unwise to contribute further funds into EFRBS or EBTS without taking full consideration of these measures and it is essential to also review the effect of the measures on existing trusts. Please see contact details at the end of this page if you require assistance in this area.

How do EFRBS work?
A discretionary trust is established (usually offshore) for the benefit of an employer company’s employees and their families. The employer transfers funds into the trust. The scheme’s trustees apply the funds via a series of sub-trusts for the benefit of the company’s employees, as they see fit, according to the trust deed. Funds have been used to confer tax-exempt or low tax benefits, or taxable salary bonuses to employees or advance sums by way of loans via a series of sub-trusts.

• Before the new Finance Bill 2011 measures were proposed the rules prevented a tax deduction in the hands of the company if transferring funds into an employee benefit trust arrangement unless a corresponding PAYE liability accrued for the employee when he receives a benefit. 
• The Finance Bill 2011 measures create an upfront tax charge which should therefore qualify for corporation tax deduction (subject to the normal rules for deductions).
• Other funds transferred into an EFRBS should qualify for a corporation tax deduction when retirement benefits are taken.

Finance Bill 2011 proposals
When a third party makes provision for what is in substance a reward or recognition or loan in connection with the employee’s employment, an income tax charge arises. This will be based on:

• a sum of money made available; or
• on the higher of the cost or market value where an asset is used to deliver the reward or recognition.

For example, where the asset in question is transferred or otherwise made available for an employee’s use and benefit as if the employee owned the asset. 

The amount concerned will count as a payment of employment income and the employer will be required to account for PAYE accordingly.

Anti-forestalling measures apply from 9 December 2010, see HM Treasury: draft legislation and proposals.

Why an EFRBS?

• To increase pension savings if the lifetime limit or annual allowance is already exceeded.
• To provide a flexible offshore fund for employees who are non-domiciled in the UK, or intend to retire abroad.
• To provide a flexible fund for an employee who is approaching 75. Under current rules an individual who is 75 must purchase an annuity. Under transitional measures included in Finance (No.2) Act he will not have to make this decision until he approaches 77. Whilst the Government decides on what is right for those of 75 and over, an EFRBS extends this period and offers complete flexibility.
• To shelter funds from Inheritance Tax (IHT). An EFRBS will pay a ten year IHT charge, there will be no IHT charge on a loan made to an employee which can be written off tax-free on death.

The hidden costs of EBTs and EFRBS

The typical EBT or EFRBS structure is used to advance loans to employees. The set up costs and on-going costs ensure that these tax planning vehicles are unlikely to be suitable for small companies.
As the loan is via a trust and not directly from the company there is no tax charge when it is made to a close company participator. This benefit may be outweighed by other costs which include:

• A set up fee will be payable to the scheme promoter or tax adviser setting up the scheme. This is usually a percentage of tax savings and is not tax deductible.
• An annual tax charge is payable by the employee in respect of beneficial loan interest. This should be charged at a market rates (not HMRC's official rate).
• An annual Class 1A Employer’s National Insurance liability.
• The trustees’ annual fees.
• As trusts are generally located offshore there is generally no tax charge on trust income or gains.
The cost of an EFRBS need to be carefully evaluated at the outset and care needs to be taken to ensure that future fees are considered. The costs of dismantling a trust should not be overlooked.

HMRC's views on EFRBS and EBTS

HMRC long considered EFRBS (and EBTs – employee benefit trusts) to be ineffective.
• It says that there is no Corporation Tax deduction for employer contributions to an EFRBS scheme on the basis that it involves no 'qualifying benefit'.
• In respect of EBTs HMRC holds the view that an Inheritance Tax charge may arise on the participators of a close company. It is necessary to ensure that they are prohibited from receiving trust capital.
• HMRC says that it “will most likely investigate tax returns where these schemes have been used and seek full settlement of the tax due, plus interest and penalties where appropriate”. 
• It is expected that the Finance Bill 2011 measures will make ERFBS unpopular with tax planners.

In its Spotlights pages, HMRC says that it is “aware of schemes where companies claim a Corporation Tax deduction for employer contributions to an EFRBS scheme on the basis that either (a) the contribution to the EFRBS or (b) a subsequent transfer to a second EFRBS is a 'qualifying benefit'. This would allow the company to secure a Corporation Tax deduction before any benefits are actually paid by the scheme to the employee. HMRC's view is that neither transaction involves the provision of a 'qualifying benefit'. Whilst it has been argued that there may be some ambiguity in the law around the meaning of the phrase 'transfer of assets' since it does not state to whom the transfer is to be made, in HMRC's view the context resolves any ambiguity.

The law defines 'qualifying benefits' and such benefits are plainly, from the context, benefits that if paid under the terms of an EFRBS might fall within the employment income charge. So in that context, a 'transfer of assets' should be interpreted as a transfer that could give rise to such a charge. This will primarily mean a transfer of assets to the employee but also includes a transfer to a member of the employee's family. Neither an employer contribution to an EFRBS nor a transfer between EFRBS gives rise to a possible employment Income Tax charge on the employee. So there is no 'qualifying benefit' entitling the employer to a deduction.” 

HEALTH Warning
It has been commented a few times that some promoters appear to exaggerate the tax benefits of EFRBS. It is extremely unwise invest in any product if you do not fully understand the consequences.

Need assistance in this area?
Please find contact details on our Virtual Tax Partner support pages.