UK: Employee Benefit Trusts

Last Updated: 8 September 2010
Article by Conor Brindley

In the June 2010 budget the coalition government confirmed that it will introduce legislation with effect from April 2011 to tackle "arrangements ... which seek to avoid, defer or reduce liabilities ... to income tax and national insurance contributions or to avoid restrictions on pension tax relief". The accompanying press notice (PN3) made it clear that the measure is aimed at arrangements which use employee benefit trusts ("EBTs") and similar vehicles, including specifically employer-financed retirement benefits schemes ("EFRBSs"). As such, perhaps now is a good time to revisit the differences between an EBT and an EFRBS and to consider some of the tax issues relevant to them.

Before considering the differences, it is probably useful to point out that many of the planning opportunities using EBTs or EFRBSs rely on achieving tax asymmetry. The asymmetry is essentially this, that the employer obtains a deduction in its computation of profits for the purposes of calculating its corporate tax liability1 without there being a corresponding liability to income tax on the employee. Even where tax asymmetry is not achieved (because no tax deduction is obtained for the employer) EBTs and EFRBSs are used in planning opportunities that seek to obtain a tax advantage for employees either by deferring the employee's income tax liability or avoiding it altogether.

An EBT is an employee benefit trust and, as such, is a generic term for all trusts or settlements created for employees. The trust itself is typically a discretionary trust with either non-UK tax resident or UK tax resident trustees.

An EFRBS is an employer-financed retirement benefits scheme and can be either a funded scheme (i.e. the employer makes contributions in advance in order to fund the benefits) or an unfunded scheme (i.e. the employer simply pays benefits on retirement or death). An EFRBS is in essence a form of EBT and, more particularly, is one that satisfies the provisions of section 393A of the Income Tax (Earnings and Pensions) Act 2003 ("ITEPA").

Section 393A ITEPA states that an EFRBS is a scheme for the provision of benefits consisting of or including "relevant benefits" to or in respect of employees or former employees of an employer.

The definition of "relevant benefits" is found in section 393B ITEPA which reads as follows:

393B Relevant Benefits

  1. In this chapter "relevant benefits" means any lump sum, gratuity or other benefit (including a non-cash benefit) provided (or to be provided):
  1. on or in anticipation of the retirement of an employee or former employee;
  2. on the death of an employee or former employee;
  3. after the retirement or death of an employee in connection with past service;
  4. on or in anticipation of, or in connection with, any change in the nature of the service of an employee; or
  5. to any person by virtue of a pension sharing order or provision relating to an employee or former employee.

However, certain benefits are carved out of this definition including pension income which is taxed under Part 9 of ITEPA and such "excluded benefits" as are benefits in respect of ill-health or disablement of an employee during service and benefits in respect of the death by accident of an employee during service2.

The wording in sections 393A and 393B is important and explains some of the concerns that HMRC have voiced in relation to steps taken relating to EFRBSs.

It is important to note that the definition of an EFRBS is a scheme which provides benefits consisting of or including relevant benefits. As such, an EFRBS is technically any form of EBT which includes within it the ability to pay a "relevant benefit". In other words an EFRBS does not have to consist exclusively for the provision of relevant benefits. As such an EFRBS could easily be an EBT which has the ability to pay a pension (not a relevant benefit) and also to pay, for example, a lump sum (a relevant benefit) on the retirement of an employee or former employee.

That said, when people refer to EBTs they are generally talking about what might be called a "plain vanilla" EBT in relation to which there is an express exclusion on paying relevant benefits whereas EFRBSs tend to include (or at least do not exclude) the power to pay relevant benefits.

Main Tax Provisions

The following table sets out the main tax provisions applicable to plain vanilla EBTs and EFRBSs in the context of planning opportunities.

Tax Provision




Inheritance Tax

(references are to the Inheritance Tax Act 1984 ("IHTA")



provisions apply to both



provisions apply to both

ss.10 & 12

ss.10 & 12

provisions apply to both



provisions apply to both

Income tax on loans received


(references are to ITEPA)

Chapter 7 of Part 3 (taxable benefits: loans)

Chapter 2 of Part 6 (benefits from non-approved pension schemes)



(CTA means the Corporation Tax Act 2009 and ITTOIA means the Income Tax (Trading and Other Income) Act 2005)

ss.1290 to 1296 CTA and ss.38 to 44 ITTOIA

ss.1290 to 1296 CTA and ss.38 to 44 ITTOIA

provisions apply to both

Deductions and "qualifying benefits"

Conditions A, B and C in s.1292 CTA and s.40 ITTOIA

Conditions A, B, C and D in s.1292 CTA and s.40 ITTOIA

Condition D only applies to EFRBSs

Inheritance Tax

Section 94 IHTA provides that where a close company makes a transfer of value inheritance tax ("IHT") will be charged as if each individual (to whom an amount is apportioned under section 94) had made a transfer of value of such an amount as would be equal to the amount so apportioned. The apportionment is made among the participators of the close company according to their respective rights and interest in the company immediately before the transfer. Clearly if the employer funding the EBT/EFRBS is not a close company, no section 94 IHT charge can arise in relation to any contribution made by the employer to the EBT/EFRBS.

The section 94 IHT charge can be avoided if the disposition (i.e. the funding) falls within section 13 IHTA. In order to fall within section 13, the EBT/ EFRBS must be an employee benefit trust falling within the definition in section 86(1) IHTA and the trust instrument must provide that where the class of beneficiaries includes participators of the company, such participators and persons connected with such participators can only benefit in a form which amounts to a payment which is the income of that person for the purposes of income tax or would be the income of such person if that person were resident in the UK (section 13(4)). In other words participators should be excluded from benefiting under an EBT/EFRBS except to the extent that there is a power to make a payment to them which is their income for the purposes of income tax or would be if they were UK tax residents.

Often an EBT/EFRBS is used to make loans to participators. In such circumstances, the issue that needs to be considered is whether or not the making of a loan is a "benefit" within the meaning in section 13(2). If the loan is a benefit, then section 13 will not apply to prevent a section 94 IHT charge. The making of an interest free loan is clearly a benefit. It should be noted that although the participator would be liable to income tax in respect of the loan, the provisions of section 13(4) would not be satisfied as the income tax liability would be by reference to the official rate of interest as opposed to the amount of the loan.

HMRC take the view that the making of a loan on arm's length terms is a benefit. However, it is arguable whether or not an arm's length loan is in fact a benefit as even though there is case law to suggest that the making of an arm's length loan could be a benefit, it would appear from the context of section 13 that a benefit for these purposes is more aimed at getting "something for nothing" (i.e. the benefit denotes an element of bounty). As such a full commercial loan should not in itself cause section 13 not to apply.

Even if protection under section 13 is not available, section 10 IHTA might provide that no section 94 IHT charge arises. Section 10 provides that a disposition (e.g. the transfer of funds into an EBT/EFRBS) is not a transfer of value if it is shown that it was not intended, and was not made in a transaction intended to confer any gratuitous benefit on any person and it is a transaction which one might have expected to occur if the parties were dealing with each other at arm's length. Given the widespread use of employee trusts as a mechanism for employees to work harder, be more productive etc. and given that but for specific anti-avoidance provisions contributions to an EBT/EFRBS would be deductible for tax purposes (on account of satisfying the "wholly and exclusively for the purpose of the company's trade" test and not being of a capital nature), it would appear that there are good arguments to support the fact that a transfer of funds to an EBT/EFRBS might be expected to be made on an arm's length transaction between unconnected persons. In other words as a cash contribution to an EBT/EFRBS is part of the normal commercial arrangements of affording incentives and benefits to staff (and thereby enhancing the value of the company) such disposition does not confer any gratuitous benefit.

It is generally felt that section 12 IHTA does not provide an escape from a section 94 charge on account of the specific anti-avoidance provisions that prevent a deduction being allowed in respect of contributions to an EBT/EFRBS. Although, a deduction should be allowed as and when any payment made by the EBT/EFRBS is subject to income tax (e.g. when a loan made by the EBT is released so that there is an employment income tax charge) section 12(1) is looking to corporation tax which is determined annually based on accounting periods and if, in the year in which a contribution to an EBT/EFRBS is made, no deduction is allowed, it is thought that section 12 cannot apply.

Section 72 IHTA provides for a tapered, or flat rate charge in some circumstances, on property leaving a section 86 trust (i.e. a trust for the benefit of employees). There are three cases in which the charge is imposed, namely:

  • where settled property ceases to be employee-trust property (otherwise than by virtue of a payment out of it);
  • where a payment is made out of employee-trust property for the benefit of certain persons (broadly speaking participators or settlors); and
  • when the trustees make a disposition (otherwise than by way of a payment) reducing the value of the employee-trust property.

Section 63 IHTA defines payment for these purposes as including a transfer of assets other than money. No charge arises where there is a payment to a participator or settlor if such payment is within section 10 IHTA (i.e. it is not intended to confer gratuitous benefit, and is either an arm's length transaction or is what might be expected in an arm's length transaction between unconnected persons). For reasons already mentioned above, no section 72 IHT charge should arise on the making of a full commercial loan to a participator.

Income Tax on Loans

Where a loan made by an EBT is an employment-related loan and is also a taxable "cheap" loan, the "cash equivalent" of the loan is treated as taxable earnings. A "cheap" loan is broadly a loan in respect of which the interest paid is less than the "official rate". The "cash equivalent" is the difference between the amount of interest that would have been payable on the loan for the year at the official rate and the amount of interest (if any) actually paid on the loan for the year. Clearly, if a loan carries a rate of interest in excess of the official rate, no income tax liability will arise in respect of such a loan.

Where the loan is made by an EFRBS, the provisions of sections 394 and 399 ITEPA apply. Section 394 broadly provides that the benefit in respect of the loan counts as employment income of the individual and section 399 provides that the individual is treated for tax purposes (other than Chapter 2 of Part 6 of ITEPA) as having paid interest on the loan equal to the cash equivalent of the loan.


Part 20 of CTA provides that no claim for relief from corporation tax for a contribution to an employees' trust is allowed (on general principles) unless, and to the extent that, in that period, or within 9 months after the end of it, "qualifying benefits" or "qualifying expenses" are paid out of the "employee benefit contributions" in question. If not, relief is deferred until the accounting period in which such qualifying benefits or expenses are paid out. "Qualifying benefits" are provided if there is a payment of money or a transfer of assets (but not the making of a loan) that meets certain conditions (Conditions A to D in section 1292 CTA). Consequently, in order for an employer to obtain a deduction in respect of payments into an EBT there has to be a payment out which satisfies Conditions A, B, C or D.

Condition A is that the payment or transfer gives rise both to an employment income tax charge and an NIC charge;

Condition B is that the payment or transfer would give rise to both charges if:

  1. the duties of the employment in respect of which the payment or transfer was made were performed in the UK; and
  2. the person in respect of whose employment the payment or transfer was made met at all relevant times the conditions as to residence or presence in the UK;

Condition C is that the payment or transfer is made in connection with the termination of the recipient's employment with the employer.

Condition D is that the payment or transfer is made under an employer-financed retirement benefits scheme.

Accordingly, if an employer were to make a contribution to an EFRBS and the EFRBS were to make a payment to an EBT (which then in turn perhaps makes a loan to an employee), the contribution should be deductible as it would satisfy Condition D. It should be noted, however, that HMRC does not consider that such a transaction involves the provision of a "qualifying benefit" (see HMRC Spotlight 6).

Other Tax Issues

Although the scope of this article does not extend to considering all tax issues relevant to EBTs and EFRBS, clearly other tax issues for example the transfer of assets abroad rules, withholding tax, NIC, loans to participator rules and the disclosure rules, need to be considered when using EBTs and EFRBSs for planning opportunities.


1 The effect of this deduction is that if an employer (which is a company) makes a tax deductible payment of £100, the actual cost to the employer (assuming it is tax paying and subject to tax at 28%) is only £72 as the £100 payment reduces its taxable profits by £100 thereby saving it £28 of corporation tax.

2 Excluded benefits tend not to be liable to tax.

This publication is intended merely to highlight issues and not to be comprehensive nor to provide legal advice. Conor Brindley heads up the tax group at Rosenblatt Solicitors and can be contacted at

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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