UK: HMRC Determined To Push Ahead With "Tax On Fresh Air"

Last Updated: 28 February 2011
Article by James Quarmby

Despite mounting criticism from the tax profession and business leaders, HMRC is indicating that it is going to push ahead with the controversial changes in tax legislation introduced in draft form on 9 December last year. It has been dubbed "the tax on fresh air" because, for the first time in the history of UK taxation, income tax will be levied on individuals in respect of employment income or benefits which have not actually been received from the employer and, indeed, may never be received. The legislation, as drafted, specifically states that the tax charge will still arise even if the employee has no legal right to any money or other benefit from the employer.

The government says that the reason it wishes to introduce this legislation is to prevent the avoidance of employment income tax by employers and their employees channelling money through third party entities such as employee benefit trusts (EBTs) and employer financed retirement benefit schemes (EFRBS). James Quarmby, Tax Partner at the law firm Thomas Eggar LLP comments: "One can understand why the government would want to stop some of the more abusive uses of EBTs - where the employer would pay money to the EBT and then a little while later that money was lent by the EBT to the employee – but instead of introducing targeted legislation to stop this type of abuse, which would have been relatively easy, it has instead wildly over-reacted and brought in rules which will catch entirely innocent arrangements between an employer and an employee regarding future performance and remuneration."

Critics argue that the legislation is contrary to the government's previously stated aim of trying to encourage employers to avoid paying large cash bonuses (particularly to bankers) and instead enter into longer-term reward structures.

The new law will impose income tax when the parties enter into the arrangement – not when the benefits are received, which is a complete reversal of the previous tax position. "If employees are going to be taxed when they enter into a deferred bonus scheme then it is highly unlikely that they will cooperate. What you must remember is that many of these schemes are entirely discretionary, which means that the employee has no guarantee that he will receive the reward in question. Naturally, the employee will not want to be taxed on bonus he may never receive. But this, incredibly, is what the legislation seeks to do," continues Quarmby.

Another unwelcome consequence of this rule is that employees will have to fund the payment of income tax out of their own recourses. Normally, employees have their tax deducted from their income before it is paid. Here there is no actual income from which to deduct the tax, which is likely to cause extreme hardship in many cases. Whilst there are a number of exceptions for so-called 'genuine' employee benefit arrangements, critics argue that the exceptions are so narrowly drafted that they are useless. "The exceptions include a few of the approved share ownership plans but very little else and the legislation is so poorly drafted that it actually removes some of the legal protections promised to members of certain pre A-day approved pension schemes," says Quarmby.

Some of the new rules have come into effect already, despite being only in draft form, and the rest of the provisions come into effect on 6th April this year. The tax profession and business leaders are urging the government to re-think the measures and to make them more targeted and proportionate to the perceived risk. Quarmby notes: "I strongly believe that to tax hard working employees on monies they have not and may never receive is unfair, immoral and an affront to the long cherished principles of our tax law. It will also place an unwelcome barrier to employers who wish to retain and incentivise their best employees. This law must be changed".

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