The FTT decision in the Rangers FC case on loans from EBTs

Why is this decision important?

The Murray Group (of which Rangers Football Club, which went into liquidation last year, formed part) operated an employee benefit trust (EBT) for the benefit of employees of a number of group companies, including Rangers FC. Sub-trusts were established for a number of employees, most of whom requested and received loans from ‘their’ sub-trust. HMRC issued assessments for income tax under PAYE and national insurance contributions which are disputed by the taxpayers.

Since the court (by a majority of 2:1) in this appeal against the assessments by the Murray Group to the First-tier Tribunal found in favour of the taxpayers, deciding that the loans were ‘genuine legal events with real legal effects’, the decision will be disappointing for HMRC in view of the stance it has taken on the use of EBTs as set out in Spotlight 5 and the ‘settlement opportunity’, details of which were published in 2010.

HMRC's analysis is that loans and other benefits provided through EBTs prior to the implementation of the disguised remuneration legislation in ITEPA 2003 Part 7A are a form of disguised employment income and should therefore be subject to PAYE and NIC and it has issued protective assessments in a number of cases.

There are significant numbers of employing companies that have established a discretionary employee benefit trust (EBT). Some of those EBTs will have made loans to employees, in respect of which the sponsoring employer may have received protective assessments to income tax through PAYE and NIC from HMRC. Such employers may see the majority judgment in this case as giving them a reprieve, since two of the three judges considered that the loans provided to employees through the Murray Group EBT were genuine loans and not emoluments subject to PAYE and NIC.

The issue considered by the tribunal was whether the payments into trust or the amounts received by the employee from the EBT should be taxed as emoluments of their employment under ITEPA 2003

Any reprieve is likely to be temporary, since there is a high likelihood of an appeal by HMRC, but it will be a number of years before any appeal by HMRC will be heard. HMRC will be helped significantly in any appeal by the opinion of the dissenting judge, Dr Heidi Poon who provides a detailed analysis of the application of the Ramsay principle or approach (WT Ramsay v IRC [1982] AC 300) and concludes that the parties' intentions must be taken into account in analysing the taxation treatment of the amounts in issue, with the result that the amounts provided to employees through the EBT were emoluments and should be taxed as such.

The implementation of the disguised remuneration legislation contained in ITEPA 2003 Part 7A now prevents companies from using an EBT to provide loans to employees without incurring an upfront income tax charge on the full amount of the loan (subject to a limited exception for trusts where a substantial proportion of their business consists of making loans to the public, ITEPA 2003 s 554F) and circumscribes significantly the other uses of EBTs by the introduction of extensive charging provisions, unless the benefits provided to beneficiaries fall within one of the specific exclusions in Part 7A or are otherwise subject to income tax under ITEPA 2003.

Although none of the existing loans made by the Murray Group EBT has been renewed, there was a finding of fact that ‘the general expectation by employees’ is that they will be renewed. However, if their terms are amended or they are renewed in the future, a Part 7A charge will apply. This will also apply to other EBTs established before Part 7A came into force.

HMRC has also published guidance (Revenue & Customs Brief 18/11, dated 4 April 2011) which sets out details of when it considers inheritance tax charges will be payable in respect of EBTs. This will be relevant for existing EBTs, since HMRC considers that the establishment of sub-trusts for the benefit of named employees causes EBTs to fail the test in IHTA 1984 s 86. However, the judges in the Rangers FC case did not consider the application of s 86 and both the majority decision and the dissenting opinion refer only briefly to inheritance tax in the context of the loans made by the EBT and whether they would constitute debts in the estates of deceased employees, thereby reducing their value for inheritance tax purposes.

Background

Rangers FC (and other employing companies within the Murray Group) arranged for monies to be paid to the EBT trustee with a direction to the trustee that a sub-trust be established for the benefit of the family of a named employee. That employee would be appointed protector of his family's sub-trust, with extended powers similar to those of the trustee, but having no title to the trust assets and no right to confer beneficial ownership of the sub-trust assets on himself. The appointment of the employee as protector is an unusual step and goes further than the arrangements described in Sempra Metals Ltd v HMRC [2008] STC (SCD) 1062 and Macdonald v Dextra Accessories Ltd [2005] UK HL 47 in suggesting that the employee's family had an entitlement to receive the funds in the sub-trust and unfettered access to them, although counsel for the taxpayers argued that the tests in Sempra and Dextra had not been satisfied.

For most of the Murray Group employees to whom the EBT arrangement was provided, a loan facility (subject to interest, albeit at a discounted rate), repayable by the employee on demand by the trustee, was made available to the employee. If a loan was taken and not repaid before the employee's death, the advice given to employees was that the resulting debt on the employee's estate would reduce the size of the estate for inheritance tax purposes.

In addition, a number of sub-trusts were established for footballers employed by Rangers FC. The salary and other taxable benefits payable to the employees were set out in the employment contract, but side letters setting out additional sums to be provided through the EBT in the form of discretionary trust payments were issued to the employees. According to the dissenting judgment by Dr Poon, the amounts set out in the side letters, when added to the amounts stated in the employment contract, formed the basis of the calculation of the agents' fees payable in respect of footballers' transfers and for the purpose of calculating the sums insured in case of injury, lending weight to the argument that those amounts were contractual payments, which should have been subject to PAYE and NIC.

Dr Poon also refers to the EBT and Murray Group payroll being used ‘interchangeably’ in connection with the awarding of salary increases. This is likely to have contributed to her conclusion that loans made through sub-trusts were emoluments subject to PAYE and NIC.

There was criticism of the trustee's role in the arrangements and it was suggested that the trustee did not exercise its discretion in making the loans and that loans were granted automatically with insufficient checks being made on the credit-worthiness of recipients.

The issue considered by the tribunal was whether the payments into trust or the amounts received by the employee from the EBT should be taxed as emoluments of their employment under ITEPA, with consequential PAYE and NIC liabilities for the employing company.

As discussed above, s 86 was not considered by the tribunal, so there is continuing uncertainty about the risk of inheritance tax charges that may arise when creating sub-trusts in s 86 EBTs.

Majority decision

The tribunal heard and accepted evidence from Counsel representing the tax payer as to the validity of the trust structure and the interpretation of the originating trust deed and various amending deeds.

Mr Kenneth Mure, QC and Scott Rae, LLB, WS gave the majority decision, stating that a purposive interpretation of earnings should be adopted. They noted the comments of Ribeiro PJ in Collector of Stamp Revenue v Arrowtown Assets Ltd [2003] HKCFA 46 at para 35:

‘The driving principle in the Ramsay [(W T Ramsay v IRC [1982] AC 300)] line of cases continues to involve a general rule of statutory construction and an unblinkered approach to the analysis of the facts. The ultimate question is whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically.’

However, they adopt the view that, as a result of the Court of Appeal's decision in CIR v Mayes [2011] EWCA Civ 407 the Ramsay approach is limited in its application by the specific statutory provisions affecting loans (ITEPA 2003 ss 173–175 and ss 188–189), the general charging provisions applicable to non-cash benefits-in-kind and the legal effect of the trust structure and loans, which were analysed by them as being ‘genuine legal events with real legal effects’. Following analysis of the charging provisions defining emoluments (for 2002/03, ICTA 1988 s 19(1); for subsequent years, ITEPA 2003 s 62) and the meaning of ‘payment’ in relation to directors' bonuses as expressed by Walton J in his judgment in Garforth v Newsmith Stainless Ltd [1979] STC 19 and subsequently clarified by Warren J's opinion in Aberdeen Asset Management PLC v HMRC FTC/94/2010, the majority confirm that the loans in this case did not amount to ‘payments’.

As regards other amounts made available through the EBT (such as bonuses for winning a UEFA champions league match or annual bonuses payable to employees of Murray Group companies, other than Rangers FC), evidence was presented that those amounts were discretionary bonuses, rather than contractual payments. This evidence was accepted by the majority which accepted that the benefit was simply a discharge of an employer's obligation to an employee and that no tax liability would arise. The amounts referable to the side letters were analysed in a similar way, despite the inclusion of those amounts in calculating agents' fees for negotiating footballers' remuneration.

Messrs Mure and Rae also considered a small number of cases where payments had been made through the EBT and where, it was conceded by counsel for the tax payer, PAYE and NIC liabilities arise. Analysis of those cases is outside the scope of this article and they are not discussed further here.

It is interesting that when invited by Messrs Mure and Rae to give a ‘considered reply’ to the question of whether HMRC would regard the loans granted to employees as debts on their respective estates on death, counsel for HMRC responded to the effect that ‘HMRC preferred not to commit itself.’ Messrs Mure and Rae comment that they ‘would have expected such a claim of indebtedness to be vigorously disputed’. This is striking, in view of HMRC's published stance on inheritance tax and sub-trusts mentioned above.

Dissenting judgment

Dr Poon's dissenting opinion offers a detailed analysis of how the Ramsay approach should be applied to the relevant legislation in this case. She describes the legislation referred to in Mayes as being highly prescriptive and formulaic and concludes that, as a result, ‘the court is precluded from any further purposive construction of the said legislation by its very prescriptiveness’.

Dr Poon goes on to consider the case of DTE Financial Services Ltd v Wilson [2001] EWCA Civ 455 and refers to the fact that it sets a ‘clear precedent’ for the use of a Ramsay approach in a PAYE context and defines the concept of payment in this context as a ‘practical, commercial concept, and specifically negates the submission that it is a legalistic concept’.

Dr Poon contrasts the decision in Mayes and the majority's circumscribed application of Ramsay to the evidence in this case with the interpretation of when a payment constitutes an emolument, which ‘has been derived entirely from case law’.

Although Dr Poon concedes that the loans are not shams and that they are real for juristic purposes, she then considers the underlying transaction as shown by the intentions of the parties, citing in support the binding authorities of the Court of Appeal decision in DTE and the House of Lords' decisions in Ramsay and MacNiven v Westmoreland Investments Ltd [2001] UKHL 6, STC [2001] 237, concluding that the payments to the sub-trusts were earnings from the outset, since the employees had unfettered access to the funds ‘if the fact of the payments is viewed realistically’. Dr Poon also considers Garforth and Aberdeen Asset Management and says, agreeing with Walton J and Warren J respectively, that for a payment to constitute an emolument it is a sufficient, but not a necessary, condition for it to be placed ‘unreservedly at the disposal’ of the employees.

In contrast to the majority decision, Dr Poon considers the inheritance tax analysis adopted by the parties to the arrangements, i.e. that the outstanding loans would constitute a debt on an employee's estate on death, thereby reducing its value for inheritance tax purposes, and concludes that if a purposive construction of the loans is adopted and they are taxable as emoluments, the debts in the sub-trusts will not reduce the employee's estate for inheritance tax.

Conclusion

Although the majority decision in favour of Rangers FC mentions Ramsay and suggests that a purposive analysis of the facts is required, it then refers to the decision in Mayes as authority for an approach that relies to a surprisingly high degree on the fact that the loan documentation stated the loans were subject to interest and repayable and that the payments were made through a discretionary trust.

The majority treated the loans as ‘genuine legal events with real legal effects’ subject to the taxing provisions applicable to loans only, which did not involve a transfer of an absolute entitlement to the employees, thereby ensuring the employing companies were not required to account for PAYE and NIC under ITEPA 2003. In contrast, the dissenting opinion by Dr Poon concentrates on a purposive interpretation (in line with Ramsay) of the underlying transactions. Dr Poon relies upon the cases of Garforth and Aberdeen Asset Management and concludes that the loans made through the EBT were payments of emoluments subject to PAYE and NIC.

Since HMRC is likely to appeal the decision, taxpayers may decide to postpone further discussions with HMRC in relation to the EBT settlement opportunity, because the decision in any appeal will take a considerable time. However, interest and penalties will continue to run on any assessments that have been issued by HMRC to date.

The parties have 56 days to appeal the decision, counting from 29 October 2012.

Sue El Hachmi is a senior associate in the incentives team at Osborne Clarke