A Spanner in the Works

WILLIAM DORRAN illustrates the practical difficulties in applying the Accounting Standards Board's Information Sheet No 48 to employee benefit trusts.

A substantial number of employee benefit trusts have been set up in recent years. On 5 July 2001, the Accounting Standards Board issued Information Sheet No 48, a consultation document in relation to the application of the principles of Financial Reporting Standard 5 and Urgent Issues Task Force 13 to an employee benefit trust. Comments were requested by 17 August, and it is understood that many were made. In what follows I offer some thoughts on the effects of implementing the information sheet assuming that the Accounting Standards Board adopts it with no changes. The information sheet can be found at www.asb.co.uk.

The characters in the following scene play out the practicalities of applying the information sheet to an employee benefit trust. The scene is an imaginary conference of all interested parties.

Illogical conclusions

Revenue accountant: This information sheet means that all employee benefit trusts will be treated as a company asset even if there is a separate trust.

Tax adviser: Does this apply in all circumstances?

Revenue accountant: I cannot imagine any circumstances when it will not apply. The legal form is irrelevant; it is the substance that counts. If the company has the risks and benefits from the arrangement, then it is just the same as if it is the company's money, and must appear on the company's balance sheet.

Tax adviser: So the fact that the trustees act independently of the company, that the money is not actually held by the company, and that the company has no arrangements with its employees or the trustees that will ensure that the employees receive payments from the trust, is all irrelevant.

Revenue accountant: Yes.

Accounts inspector: As I understand it, when the money is paid out of the trust the company can have tax relief.

Tax adviser: Would you agree that the company can also get tax relief if it provides a benefit for its employees? For example, what if the trust were to buy a cricket pitch for use by the employees?

Accounts inspector: I would agree that relief would be available to the company for expenditure of that nature.

Tax adviser: Would it matter whether or not the employee had a P11D benefit charge?

Accounts inspector: No, that would not be important. It is the fact that the trust is spending money on employees in accordance with the trust deed that gives rise to a deduction.

Tax adviser: So this could mean that a deduction could be available for expenditure which, if made by the company, would not give rise to a deduction on the grounds that it is capital.

Revenue accountant: No, I disagree with the Inspector. The cricket pitch will be treated as an asset of the company, so no deduction will be available.

Tax adviser: Suppose the trust had bought land for use as a cricket pitch, that the land was close to the company's premises, and as a special purchaser the trust paid over the odds. If the land was revalued to market value, then would the company get a deduction for a loss on revaluation?

Revenue accountant: Yes, the company could have a deduction for that.

Tax adviser: So, what if the trust sold the land at a profit?

Accounts inspector: I do not think that profit is taxable.

Revenue accountant: I agree.

Tax adviser: That is presumably because the profit belongs to the trust and not the company.

Trust inspector: We have a number of trust returns from employee benefit trusts. Perhaps I should enquire into them.

Revenue accountant: I cannot see why you should have any returns for employee benefit trusts. The money is treated as belonging to the company, so the income should go on the company's return.

Trustee: What if the trustees do not tell the company's directors what they have done with the money?

Revenue accountant: That is unlikely to happen but, if it did, the company would have to write off the money on the grounds of uncertainty. I would need to consider various accounting standards, but it would have to be something that would reflect the lack of clarity in the situation.

Tax adviser: I would have thought that it would be the clarity of the situation that would enable the company to derecognise that asset. You told us earlier that the fact that the trustees act independently, and that the trustees actually have the money, is irrelevant, but when these features are actually present, you change your tune and seek to justify this based on some accounting standard rather than recognising that this new information sheet is unworkable in practice.

Trust inspector: Surely the reason that both the income and gains of the trust are taxable on the trust and not the company, is that the anti-avoidance legislation at section 660A, Taxes Act 1988 and section 77, Taxation of Chargeable Gains Act 1992 is not triggered. The company would have to be able to benefit from the trust by being able to receive the money held by the trust or by receiving an interest- free loan, and surely any trust set up by a lawyer with any experience of trusts would automatically ensure that the settlor could not benefit from the trust. Furthermore these commercial trusts are normally outside the scope of that legislation in any event.

Investor: It seems to me that if the assets of an employee benefit trust are included on the balance sheet of the company that set up the trust, then the amount shown as 'shareholders funds' will be misleading, and the company's earnings will be overstated. This could mean that I will pay more for the shares than they are really worth, and if I do I will be looking for compensation. The auditors had better watch out.

Auditor: My defence would be that I was following orders.

Bank manager: I am going to have difficulty with lending to companies if I cannot rely on the accounts. I thought that the auditor had to say that the accounts were fair and truthful. How can the bank take a charge over assets shown on a company's balance sheet if they actually belong to somebody else? I cannot see the trustees giving a guarantee for the company's borrowing.

Insolvency practitioner: If the company gets into difficulties, how will the assets held by a trust be available to the creditors, unless the company put the money into the trust deliberately in order to defeat the claims of creditors?

What next?

So it seems that everyone is perplexed. The trust inspector cannot understand how he can enquire into a return that he thinks is correct, on the grounds the income should be treated as that of somebody else, when he can see no basis in tax law for this. The accounts inspector wonders how he can deal with the situation where an employee benefit trust has a capital loss and a capital gain. Does the company get relief for the loss, and is the trust taxed on the gain, or can they be offset? What if the company pays a contribution to the trust, and in the same year the company makes payments out of the trust. How are they matched?

Meanwhile the auditor, contemplating being sued by the investor, might like to consider the following appeal made by Archbishop Romero:

'Brothers, you came from our own people. You are killing your own brothers. Any human order to kill must be subordinate to the law of God, which says, "Thou shalt not kill". No soldier is obliged to obey an order contrary to the law of God. No-one has to obey an immoral law. It is high time you obeyed your consciences rather than sinful orders. The church cannot remain silent before such an abomination.... In the name of God, in the name of this suffering people whose cry rises to heaven more loudly each day, I implore you, I beg you, I order you: stop the repression.'

The day following this speech, Archbishop Romero was murdered.

William Dorran FMAAT, ATII is a tax manager with Turner Peachey, Shrewsbury.

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