Life in the Real World

WILLIAM DORRAN of Turner Peachey, Shrewsbury, continues his scrutiny of the implications of Urgent Issues Task Force Information Sheet No 48 on employee benefit trusts.

THE POTENTIAL CONFUSION arising from trying to apply Urgent Issues Task Force Information Sheet No 48 to employee benefit trusts was illustrated in my previous article (see Taxation, 15 November 2001 at pages 157 and 158). I have the impression that the Urgent Issues Task Force has not given consideration to all the implications of what it proposes, such as the trust, tax and insolvency consequences. The accounting treatment does not exist in a vacuum. In many ways the proposed test of de facto control is appropriate, but the lack of a definition or guidelines on how to recognise such control is the flaw in the Information Sheet. It is interesting to consider how 'de facto control' has been defined in other legal contexts.

According to Malcolm CJ in Connelly v Lavender [1991] 5 ASCR 33:

'"Effective control" in the context of the statute (Crimes (Confiscation of Profits) Act 1988 (WA)) means de facto control. The expression contemplates control that is practically effective, in the sense that the person concerned has in fact the capacity to control the possession, use, or disposition of the property. This is, in my opinion, the meaning of effective control unadorned or unencumbered by the definition in paragraph 3(1) of section 52a of the Act.'

In Attorney General's Reference (No 2 of 1995) [1996] 3 All ER 860, Lord Justice Rose stated:

'In our judgment it is clear, indeed from what we have said it is common ground, that Parliament in referring to "control, direction or influence" contemplated three different types of behaviour in relation to a prostitute's movements. The words, at first blush, suggest progressively wider categories and are plainly to be construed disjunctively. As a matter of construction, although compulsion or persuasion may well be a necessary component of control, and possibly direction, and although (depending on the circumstances) compulsion or persuasion may be an ingredient of influence, we do not accept that compulsion or persuasion are necessary ingredients of influence.

'In our judgment, power to produce effects and the ability to affect, do not necessarily equate with conduct bringing about, causatively, particular consequences. They are not concepts which embrace within them, of necessity, compulsion or persuasion or, for that matter, inducement. Something may influence a person's decision without in itself persuading them to a particular course of conduct.

'As a matter of language, we are clearly of the view that, both in its context, following the words "control and direction", and in itself, the word "influence" does not import either compulsion or persuasion, nor does it imply the existence of any sort of sanction. This construction is entirely consonant with the distinction drawn by the concluding words of the section relating to aiding, abetting or compelling.'

In The Arantzazu Mendi [1939] 1 All ER 719, the nationalist Government of Spain wished to have a writ set aside on the grounds that it impleaded a foreign government:

'In a letter dated 28 May 1938 from the Foreign Secretary after stating that His Majesty's Government recognises the Government of the Spanish Republic as the only de jure Government of Spain or any part of it, the letter proceeds as follows:

'5. His Majesty's Government recognises the nationalist Government as a government which at present exercises de facto administrative control over the larger part of Spain.

'6. His Majesty's Government recognises that the nationalist Government now exercises effective administrative control over all the Basque provinces of Spain.

'8. The nationalist Government is not a government subordinate to any other government in Spain.

'My Lords, this letter appears to me to dispose of the controversy. By "exercising de facto administrative control" or "exercising effective administrative control", I understand exercising all the functions of a sovereign government, in maintaining law and order, instituting and maintaining courts of justice, and adopting or imposing laws regulating the relations of the inhabitants of the territory with one another and with the government. It necessarily implies the ownership and control of property, whether for military or civil purposes, including vessels, whether warships or merchant ships.'

Looking at the above three cases, de facto control is not some sort of woolly suggestion to the trustees of an employee benefit trust, but it requires:

• the capacity to control the possession, use or disposition of the property;
• compulsion or persuasion;
• the ownership and control of property.

These are strong words, and in effect mean that the trustees have given up any form of control over the property with which they were entrusted.

Appointment of trustees

It has been suggested that if the company has the power to appoint trustees, the company effectively has control over the employee benefit trust. However, in a Canadian case, R v Campbell [1999] TCC 95-3238(IT) G, the report concludes:

'In my view, none of the decisions cited on behalf of the respondent support the proposition that the power to remove and appoint trustees is alone sufficient to amount to control of a company, the shares of which are held by the trustee. There is no basis upon which this court could conclude that trustees would neglect their fiduciary duty to exercise their voting rights in accordance with their independent judgment and would follow the wishes of another person solely because of the risk of being removed and replaced by another trustee.'

Likewise in Re Power's Settlement Trusts; Power and Others v Power [1951] 2 All ER 513, it was held that a settlor who had the statutory power of appointing additional trustees of a settlement under section 36(6), Trustee Act 1925 was not entitled to appoint himself an additional trustee.

Substance over form

The concept of showing assets that are legally owned by another in a company's accounts relies upon the doctrine of substance over form and from an accounting viewpoint it is set out in Financial Reporting Standard 5. In the United Kingdom, it seems to have had its zenith in the familiar case of W T Ramsay Ltd v Commissioners of Inland Revenue 54 TC 101.

In a case regarding the Rent Acts, AG Securities v Vaughan, Antoniades v Villiers [1988] 3 All ER 1058, Lord Templeman said that to consider the substance and not the legal form there must be some 'pretence'. However, this concept of substance over form now seems to be on the back burner. In two cases heard this year by the House of Lords the concept was not considered. Firstly, in Commissioner of Inland Revenue v Auckland Harbour Board (New Zealand) [2001] STC 130, the harbour board feared that it was to be wound up, and to reduce the financial consequences of this, it transferred assets to two trusts that it set up. Under the equivalent of the United Kingdom loan relationship rules, the harbour board could claim a loss on transfer.

Secondly, in Westmoreland Investments Ltd v MacNiven [2001] STC 44, a trust borrowed from the company that controlled it so that the trust could pay interest to the company. It was nevertheless able to claim that in reality, the interest had been paid even though it had to borrow from the company to enable it to do so.

Therefore, I suggest that the Accounting Standards Board needs to take the current climate for this concept into account in considering what guidance should be issued following its deliberations over Information Sheet No 48. The concept of substance over form has clearly been relegated in Canada as can be seen from Shell Canada Ltd v Canada [1999] 3 SCR 622. The full judgment can be viewed at www.canlii.org/ca/cas/scc/1999/1999scc67.html.

But in any event, how important are accounting standards from a tax viewpoint? A company is required under section 226(2), Companies Act 1985 to prepare its accounts giving a true and fair view. Additionally, section 42(1), Finance Act 1998 reads 'For the purposes of Case I or II of Schedule D the profits of a trade, profession or vocation must be computed on an accounting basis which gives a true and fair view, subject to any adjustment required or authorised by law in computing profits for those purposes'. Given the proposal that there should be world-wide accounting standards within the next five years, and that the current United Kingdom proposals should more fully align accounting and taxable profits, it seems that we are in for a bumpy ride. There may well be some backtracking by the Revenue in universally accepting accounting standards, bearing in mind the differences one can see now with accounts prepared under United Kingdom and foreign countries' generally accepted accounting principles.

Counsel's opinion

In an opinion given to the forerunner of the Accounting Standards Board, the Accounting Standards Commission on 13 September 1983, Dame Mary Arden and Lord Hoffmann said:

'We therefore see no conflict between the functions of the Accounting Standards Commission in formulating standards which it declares to be essential to true and fair accounts and the function of the courts in deciding whether the accounts satisfy the law. The courts are of course not bound by a statement of standard accounting practice. A court may say that accounts which ignore them are nevertheless true and fair. But the immediate effect of a statement of standard accounting practice is to strengthen the likelihood that a court will hold that compliance with the prescribed standard is necessary for the accounts to give a true and fair view. In the absence of a statement of standard accounting practice, a court is unlikely to reject accounts drawn up in accordance with principles which command some respectable professional support. The issue of a statement of standard accounting practice has the effect, …, of creating a prima facie presumption that accounts which do not comply are not true and fair. This presumption is then strengthened or weakened by the extent to which the statement of standard accounting practice is actually accepted and applied. Universal acceptance means that it is highly unlikely that a court would accept accounts drawn up according to different principles. On the other hand, if there remains a strong body of professional opinion which consistently opts out of applying the statement of standard accounting practice, giving reasons which the Accounting Standards Commission may consider inadequate, the prima facie presumption against such accounts is weakened.'

What should be said

It needs to be remembered that accounting standards and Urgent Issues Task Force abstracts are not the law, but guidance or interpretative aids, and that the judges have the final say. It would surely be humiliating for the Urgent Issues Task Force if, in a forthcoming case, the courts were to consider that Information Sheet No 48 should not be applied on the basis that it was formulated on a defunct principle. Clearly, the concept of substance over form needs to be available as regards an employee benefit trust in certain circumstances, such as where a Maxwell type situation has arisen. However, this is not the norm, and in my view the Information Sheet needs to have built into it factors which the accountant can consider in formulating a judgment as to the appropriate accounting treatment. I suggest these should be as follows.

• Whether there is a provision in the trust deed that will allow majority decisions. The normal position in a trust is that decisions must be made unanimously. See Wyse v Abbott 8R 983 and Darling v Darling 25R 747.
• That there is a trustee who is not a director or senior manager of the company. The courts have found that where there is one independent trustee, then the trustees can be said to act independently of the settlor. See Clark and the Langrange Trust and Investment Co Ltd (in liquidation) v Commissioners of Inland Revenue 28 TC 55. Additionally there are a number of cases where the directors of a subsidiary have been seen to act independently of those of the parent company. See Untelrab Ltd and Others v McGregor (SpC 55) and, more recently, The Queen on the application of Commissioners of Inland Revenue, the Crown Court at Kingston and Robin Wayne John (heard on 24 July 2001).
• The trustees have regular meetings to consider the affairs of the trust. Meetings should occur at least twice a year to satisfy this requirement.
• The trust property is vested in the trustees and not held by the company.
• All the trustees must give instructions to the bank including the signing of cheques.
• The company has no agreement or arrangement with its employees that services provided by the employees to the sponsoring entity will be rewarded by payment from the employee benefit trust.
• The employee benefit trust is a discretionary trust from which the settlor company is excluded from all benefit.
• The income generated from investment by the employee benefit trust is received by the trust and not the settlor company.
• The trust deed or any other document should not give the company power of appointment over the trust fund, or to select beneficiaries, or power of veto.
• The settlor company should not make loans to the trust or give any form of financial assistance to the trustees such as a guarantee to a lender to the trust.
• The trust should not hold shares in the settlor company.
• The trust should not make loans to the settlor company on non-commercial terms.
• Any court should not be able to set aside the transfer to the trust in that the provisions of section 238(5), Insolvency Act 1986 are complied with, i.e. 'that the company which entered into the transaction did so in good faith and for the purposes of carrying on its business, and that at the time it did so there were reasonable grounds for believing that the transaction would benefit the company.'

In conclusion I consider that when these factors are taken into consideration, it is possible to properly evaluate the appropriate accounting treatment. As with considering the employment versus self-employment question, it is not the overall picture that counts.

Will common sense prevail?

The Revenue says that a taxpayer is taking a case before the Special Commissioners at the end of 2001 or early 2002, regarding the deductibility of payments to an employee benefit trust. I understand that the Revenue has some objections to the way in which this trust has been run, so it is possible that, as in Mawsley Machinery Ltd v Robinson (SpC 170), the question of accounting principles will be ignored and the decision will be taken on other grounds. If so, given the number of employee benefit trusts which have been set up over recent years, it would seem that the Special Commissioners and perhaps the courts will have to consider the application of the accounting treatment unless the Accounting Standards Board comes up with guidance shortly which reflects commercial reality rather than the outmoded and fundamentalist principles expressed in Information Sheet No 48.

Issue: 3834 / Categories: