An EFRBS (or EFURB) is a unapproved pension scheme which means that it does not share quite the same tax advantages of a conventional occupational pension scheme. An EFRBS is generally located offshore and may be a suitable retirement benefits wrapper for non-domiciled employees or workers who are living and thinking of retirement abroad.
This note provides a brief outline of EFRBS and discusses some of the tax avoidance elements.
Anti-avoidance legislation introduced in Part 7A of ITEPA 2003 via the 2011 Finance Act is designed 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 applied from 9 December 2010 these were designed to prevent tax avoidance between the announcement of new measures and the enactment of the 2011 Finance Act.
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 company 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, or their families according to the trust deed. The EFRBS Funds are on paper at least, set up to provide retirement benefits but what appeals to the tax avoidance industry is that they may be used confer tax-exempt or low tax benefits or to advance sums of cash by way of loans via a series of sub-trusts to individuals. Loans made to individuals are repayable and they will therefore be deducted from the individual's estate on death. There is no tax charge on a loan, and so HMRC introduced new rules in Part 7a ITEPA 2003 to crystalise an income tax charge as soon as the employer decides to provide funds for an employee.
- Before the new Part 7a measures were proposed, the existing rules prevented a corporation tax deduction in the hands of the company where it transferred funds into an employee benefit trust arrangement unless a corresponding PAYE liability accrued for the employee when he receives a benefit.
- Part 7a creates an upfront income tax charge, and this 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.
Part 7a ITEPA 2003
When a third party earmarks (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.
Why use an EFRBS?
- To increase pension savings if the UK 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 may extend 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. These type of trust are set up offshore for capital gains tax purposes and so the cost of trustees may be prohibitively expensive.
As the loan is via a trust and not directly from the company there was no s455 CTA 2010 tax charge when it is made to a close company participator. This position has to be reviewed following new measures introduced in the 2013 Finance Act are designed to tax disguised loans, see Close Companies, tax planning and pitfalls.
Other costs that a potential EFRBS user may pay 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.
- 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 has long considered EFRBS (and EBTs – employee benefit trusts) are ineffective for avoiding PAYE.
- 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 held the view that an Inheritance Tax charge may arise on the participators of a close company. It is necessary to ensure that those invididuals are prohibited from receiving trust capital. However many commentators do not agree with HMRC on this aspect.
- HMRC operated a policy of investigating tax returns where these schemes have been used and seek full settlement of the tax due, plus interest and penalties where appropriate.
- New measures including Part 7a ITEPA make ERFBS less popular with tax planners, see Close company EBTs.
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.”
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.
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