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KEY POINTS
- The new disguised remuneration rules are in ITEPA 2003, s 554A et seq.
- Three relevant steps may result in a PAYE liability.
- Unwinding a step may not lead to a tax refund.
- A summary of pitfall areas such as EBTs and EFRBS.
- The importance of record-keeping.
The bongo player and (slightly more notably) Nobel prize-winner Richard Feynman made the telling observation that ‘the exception proves that the rule is wrong’.
If ever there was an example of this in tax it is the new disguised remuneration rules contained in FA 2011, Sch 2 (‘Employment income provided through third parties’) which are at the same time wrong-headed and mostly ‘exceptions’.
The rules are contained in new Part 7A (s 554A to s 554Z21) of ITEPA 2003 and are to be supplemented by regulations and about which we already have numerous frequently asked questions (FAQs).
There will also, in the fullness of time, be corresponding National Insurance contributions regulations and HMRC manuals, but those have yet to break cover.
As background, the Explanatory Notes to the Finance Bill summarise the new rules as follows:
‘The schedule introduces rules that will apply in certain circumstances where employees and their employers enter into arrangements which result in a payment of money or the provision of an asset by a third party rather than the employer. The new rules create a tax charge which will apply to:
- certain loans of money or assets by third parties to the employee;
- the earmarking of money or assets for the employee by a third party and in very limited cases by the employer; and
- the outright payments of money or transfers of assets to the employee by a third party;
‘where these are not otherwise charged to tax as earnings from the employment.’
The basic conditions for the disguised remuneration rules to apply are that there must be:
- an employer, referred to as ‘B’;
- an employee, or a former or prospective employee of B, referred to as A;
- a ‘relevant arrangement’;
- a ‘relevant third party’, ‘P’; and
- a ‘relevant step’, taken by P.
A herd of ‘relevants’
The use of the word ‘relevant’ suggests that the definitions may be specialised, but in fact the word is almost superfluous and is used simply to refer to terms that are covered by the legislation, so:
‘relevant arrangement’ really just means the arrangement under consideration;
‘relevant third party’ in truth simply means any third party who has anything to do with the arrangement, including A or B if they are acting as a trustee (s 554A(7)); and
a ‘relevant step’ means one of the three types of step defined in s 554B to s 554D.
Tax will be payable through PAYE when a relevant third party takes one of three types of step: earmarking, payment or transfer, and making available.
- Earmarking (s 554B). Earmarking takes place when any money or other asset held by any third party (P) is earmarked, ‘however informally’, and that earmarking should be ‘with a view to’ another relevant step being taken. So at this stage there doesn’t have to be any decision as to who is going to benefit from the property subject to the step, simply a step which may eventually lead to A (remember him, the employee?) obtaining some benefit from the property.
- Payment or transfer (s 554C). This very wide-ranging term embraces all forms of direct and indirect transfer of ownership of, and interests in, money and other assets including even providing security for loans and making or arranging for leases of property which are likely to last for 21 years or longer.
- Making an asset available (s 554D). Where an asset is made available on terms equivalent to transferring the benefit of ownership and enjoyment tax is charged on the value of the asset transferred. The intention is to catch any arrangement whereby A becomes the owner of an asset in all but name.
There is a further catch for former employees: s 554D imposes a charge on the entire value of an asset, even if it is not ‘owned in all but name’ if it is made available after the second anniversary of termination of employment.
Exclusion is provided for transactions under employee benefit packages (s 554G), but tempered by HMRC’s insistence that such packages must be available to employees generally and not have a tax avoidance motive.
FAQs 8 and 9 give some comfort here, confirming that benefit packages open to at least 50% of the employees of an employer or a group of employees of comparable status will generally be accepted as available to a substantial proportion of employees but, clearly, no arrangement available to senior employees or directors which HMRC identifies as having an avoidance motive will be allowed to escape.
Going forward, at least until the new rules have bedded in, employers will need to be careful that the benefits they offer through third party schemes are very much of the ‘plain vanilla’ flavour.
In cases of doubt, reference to HMRC is often going to be necessary because the FAQs are couched only in the most general of terms.
Payment of the tax liability
When a step occurs it is B, the employer, who is obliged to pay over PAYE on the value of the step. That PAYE is due as part of the monthly PAYE liability.
This applies to all disguised remuneration steps occurring on or after 6 April 2011 with the modification that steps occurring between 6 April and Royal Assent are deemed to take place thirty days after royal assent.
This places a severe burden on employers to ascertain what steps have happened since 6 April 2011 and account for them in the PAYE return for the month in which the thirtieth day after Royal Assent falls. Given that Royal Assent was on 19 July 2011 that is going to mean PAYE falling due for payment no later than 19 September 2011.
For steps taken between 9 December 2010 and 5 April 2011, transitional rules apply which will treat any steps taken within that period as occurring on 6 April 2012 unless they are unwound before that date.
The general rule is that tax is not refundable if the ‘step’ is unwound, e.g. a loan is repaid or an asset transferred back to the provider (even if that is done before the PAYE falls due).
However, tax paid on ‘earmarking’ steps may become repayable if the arrangements are changed so that the employee ceases to be capable of benefiting from the earmarked property and no other person becomes able to benefit from it.
When the disguised remuneration rules apply they take precedence over the normal PAYE rules and are likely to impose not only earlier but also higher liabilities at the time of the steps concerned.
If tax has already been accounted for under PAYE that tax can be credited against the disguised remuneration tax. But that will not necessarily stop additional PAYE liabilities arising later.
Section 554Z13 applies to reduce the tax payable by the recipient of remuneration or benefit following a relevant step but it will only apply to reduce the tax payable on the subsequent event by so much as is just and reasonable and not to less than zero.
So there will be no repayments of tax overpaid as a result of asset values falling or other circumstances intervening to reduce the value ultimately taxable on B (the employee) or any other relevant person at a later date.
The tax cost of disguised remuneration may be compounded where the employee does not make good the PAYE to the employer within 90 days as, in many instances, the PAYE itself will then become a taxable benefit.
In the case of an employee loan of £100,000 the tax and employee’s National Insurance contributions (charged on the amount lent, not the notional interest) could amount to £52,000.
Adding in ‘tax on tax’ under ITEPA 2003, s 222 would result in a further tax charge of £25,000 and the employer’s NICs might be £20,700.
The pitfalls
The danger is that it will be smaller employers who are most at risk since they may not benefit from the exclusion of schemes providing benefits to ‘substantial proportions’ of their employees.
FAQ 35 makes it clear that there is no exemption from the disguised remuneration rules for any employer-financed retirement benefits scheme (EFRBS).
For example, a company which makes provision to set aside cash to purchase a pension for an employee will be caught because the new rules treat this as effectively an EFRBS, even though there is no third party involved.
The employer here is treated as a relevant third party, i.e. as if it was a trustee, and even the most tentative form of earmarking of funds as a relevant step.
It might be that the gap between earmarking and payment into a pension was short but in the meantime a PAYE payment could be missed and that could be grounds for investigation, an in-year penalty or a black mark when totting up defaults towards withdrawal of a construction industry scheme (CIS) gross payment certificate.
Changes of employee for whom benefits are earmarked can give rise to further charges:
- An asset held by an employee benefit trust (EBT) and earmarked in 2008 for one employee which is reallocated to another after 6 April 2011 will create a relevant step and the value of the step will depend on the cash sum or value of the asset involved at the time of the reallocation.
- Where an asset first earmarked in 2011/12 at one value is reallocated later at a higher value a second charge will arise, effectively on any increase in value (but with no possible contra-deduction for any fall in value).
There are traps due to the inconsistencies within the exclusions, for example:
- the car loan exclusion is limited to loans of no more than four years; and
- the ‘cashless exercise’ of share options creates a loan which, if it is not repaid within 40 days of exercise of the option, falls within the disguised remuneration provisions.
It will be necessary to keep track of changes in case they create relevant steps and to identify when it may be possible to reclaim tax paid under disguised remuneration.
These occasions will only arise when it is no longer possible for the relevant employee to benefit from the scheme, e.g. on leaving employment or death, but repayment will only be available when all possibility of benefit has been extinguished.
Potential pitfalls and partnerships
Regarding potential pitfalls, the most obviously affected employers will be those involved with existing:
- employee benefit trusts;
- employer-financed retirement benefits schemes;
- loan arrangements which involve a third person;
- international assignees with loans, tax equalisation loans or international pension plans;
- share plans, in particular non-tax approved plans; and
- pay and benefit outsourcing arrangements.
But they are in the realm of ‘known unknowns’. The real problems will arise for the innocents abroad for whom the unknowns are as yet unknown.
As far as partnerships are concerned, it is becoming increasingly popular for partnerships to adopt limited liability partnership (LLP) status and those that do may take advantage of the exclusion of wholly-owned companies from being treated as third parties, but there are traps here for the unwary.
The exclusion only applies to LLPs whose ‘subsidiary’ company is wholly owned. Therefore a company jointly owned by more than one LLP as a service provider will not benefit from the exclusion. Nor will a company substantially controlled by an LLP but not owned 100%.
Even where the company is wholly owned it may still be treated as a third party if it acts as a trustee of any arrangement.
Furthermore, the exclusion is specifically limited to LLPs. Companies owned by open partnerships and limited partnerships do not enjoy any exclusion.
A sporting chance?
But the connection does not need to be so close. For example, if an employer of any type rents a hospitality suite at a football ground the football club is a relevant third party and the moment any employee is allocated the use or enjoyment of the suite that is earmarking and the potential for a disguised remuneration charge arises.
Much of the popularity (such as it may have been) of cycle to work schemes has been the opportunity for the employee to eventually become the owner of a nice, shiny, high-status bike, and usually at an advantageous second-hand value.
This is an arrangement involving an asset that is likely to become owned by the employee and is provided by a third party, the scheme provider.
Even before we get to HMRC’s pet arguments about the second-hand value of the bike when it is bought, this is an arrangement within the disguised remuneration regime.
The normal argument would be that it should be excluded if it is available to at least half of the employer’s staff, or at least half of those of comparable status but if the scheme is sold on the basis of ‘advantageous’, possibly unrealistically low, second-hand purchase prices it may be seen by HMRC as calculated to provide a tax advantage.
If that is the case, the potential penalty is not an adjustment to the benefit in kind that the employee receives by buying the bike at a discount at some later time; instead, the disguised remuneration charge will be based on whichever is higher of the cost to the employer of providing the scheme and the value of the bike when new.
And the time of charge will be when the bike is allocated to the employee. At least, that is the potential line of argument from HMRC.
There be dragons
The underlying message of this article is that employers, advisers and HMRC alike are entering into largely unknown territory.
HMRC may think they know their way around it better because they drew the map, but their map is of territory that has yet to be explored.
It is likely to take some time and a lot of argument before the full implications of the disguised remuneration rules are understood and so it is essential that all concerned should travel carefully, keep their eyes open and watch their steps.
Chris Williams is technical associate director with Baker Tilly, based in Liverpool and technical officer to Baker Tilly’s employer consulting group. He can be contacted by telephone on 0151 600 2600 and on email
