CORPORATION TAX DEDUCTIONS AND EMPLOYEE BENEFIT TRUSTS
In the second of two contributions on Employee Benefit Trusts
Gregory Morris warns that all is not what it might seem with corporation tax deductions
for corporate contributions
(taken from Issue No 20 – July 2002
Over the last year or so the Inland Revenue have denied many companies a corporation tax deduction for donations made to employee benefit trusts. This may have potentially serious consequence for trustees, particularly where the employee benefit trust was created a close company.
The Inland Revenue has justified the refusal to allow a corporation tax deduction under a number of heads. For example the Revenue seek to deny a deduction on the basis that the provisions of s.74(1)a Income and Corporation Taxes Act 1988are not satisfied. The Inland Revenue has a certain measure of support in its position following the decision in the 1957 case of Samuel Dracup & Sons Ltd -v- Dakin1. In addition the Inland Revenue are likely to refer to s.43 Finance Act 1989 which denies a corporation deduction to a company unless taxable emoluments are received within 9 months after year end of the company.
The Inland Revenue has been supported in its position by the requirement that accounts are prepared in accordance with the provisions of UITF 13 and 32. As is well known these UITFs assume that the sponsoring company has some measure of continued control of the trust and a profit and loss account debit cannot be taken until the `control` is severed. The proposal that a debit in the profit and loss account is required because of the requirement under FRS 12 that a `constructive obligation` should be recognised (which, it is argued overrides the provisions of UITF 13 and 32), has also been resisted by the Inland Revenue.
On the basis that a corporation tax deduction is denied by the Inland Revenue what are the consequences for a trust established by a close company?
In summary, many employee benefit trusts established by close companies contain provisions that treat participators holding more than 5% of the shares in the company as excluded beneficiaries. Excluded beneficiaries are not allowed to benefit under the terms of the trust unless:
- the part of the trust fund which is applied for the benefit of such an excluded beneficiary is received in a form of payment which is income in the hands of that excluded beneficiary; or
- the company obtains a corporation tax deduction for donations made to the trust.
A significant number of close companies, often advised by national accountancy practices, have established employee benefit trusts. These trusts have been used for a number of purposes including the purchase of cars in order to obtain a `100% corporation tax deduction`, the incorporation of a special company by the trustee of the employee benefit trust that has preferred dividend shares which are then transferred to directors or other employees or even the use of a depreciating currency, for example Turkish lire, to provide a loan to a director or other employee which results in a tax free benefit to the borrower when the Turkish lire has depreciated and the loan is repaid. Many of the directors or employees that have benefited from such arrangements will be `excluded beneficiaries`.
It is assumed that the trustee would not have agreed to participate in such arrangements unless a corporation tax deduction was available. This may prove to be a reckless assumption as many trusts only allow an excluded beneficiary to benefit if it has been determined that a corporation tax deduction is available. It is considered that `determined` in the context of corporation tax may have connotations of `agreed with the Inland Revenue` as under the provisions of s.54 TMA 1970. If a corporation tax deduction is not available then the trustee may have applied the trust fund for the benefit of an excluded beneficiary.
Subject to the terms of the trust deed, there is a possibility that many trustees will have acted in breach of trust in such circumstances. In addition, notwithstanding the terms of the trust deed, it may be very embarrassing for a number of independent professional trustees if it becomes known that the trustee has acted in breach of the terms of the trust. This is particularly the case where the trustee is a `captive` of the firm of accountants that was sponsoring and advising on the arrangement or scheme.
It is understood that the Inland Revenue have for some time been waiting for an appropriate case to take before the special commissioners involving an employee benefit trust. As the readers will be aware, following the Mawsley case in 19982the use of employee benefit trusts has been restricted. We will have to wait and see the consequences of the Revenue’s latest foray into this field particularly as it is expected that a case will be heard before the Special Commissioners later this summer.
In the meantime it is suggested that all corporate trustees consider carefully those arrangements in which they have been involved, that may have resulted in excluded beneficiaries benefiting from the employee benefit trust.
Director, Tax Consultancy
1 (1957) 37 TC 377
2 Mawsley Machinery Ltd v Robinson (Inspector of Taxes) (1998) STC (SCD) 236