EBT payments to employee must be net of tax and charges – Shah v Insafe

Fri 27 May 2016

How much is an employee entitled to receive from an employee benefit trust (EBT) when the employer has settled the PAYE, NIC and interest liabilities with HMRC? That was the subject matter of Shah v Insafe International Ltd. and Bullock ([2016] EWHC 1036 (Ch)).

Insafe created EBTs and sub-trusts to reward its main director and 80% shareholder and Mr. Shah, the Finance Director, who owned the remaining 20%.

After challenge by HMRC, Insafe took advantage of the EBT Settlement Opportunity (EBTSO), paying the full PAYE income tax and NIC due with interest but no penalty. The trusts then paid Shah his share of the funds held by the trustees, net of PAYE and employee’s NIC, and of a sum representing legal costs incurred in the dispute and with interest at 1.19% over (NatWest) base rate, due from Insafe to the trusts on the funds loaned back to Insafe before payment to Shah.

Shah took Insafe to court, contending that he was entitled to receive the sums paid into the EBT without deduction of PAYE, NIC or costs and with interest at 3% over base rate, not 1.19% (the effective interest rate allowing for a discount offered by the trustees to ensure that the company did not show a loss).

PAYE and NIC- Rangers case followed
The Court followed the judgment in the ‘Rangers’ case, Advocate General for Scotland v Murray Group Holdings Ltd [2016] STC 468 to the effect that:

• payments derived from an employment into an EBT for an employee are the employee’s earnings;
• the employee is taxable on those earnings; and
• the employer is responsible for deducting PAYE and NIC on those earnings.

The Court then considered the terms of the Trust Deed which specifically provided that the employer could call upon the Trustees for reimbursement of all taxes deducted (and specifically considered that the sum paid under the settlement opportunity was an amount an employer is required to account for PAYE and NICs), so that the Trustees would then only be left holding net sums for the benefit of the employee.

Therefore Shah’s claim that, effectively, he was entitled to be paid the full amount of his earnings without deduction of tax (albeit that he accepted that he would have a personal liability to tax on sums paid from the trusts), failed.

Interest – follow the Trust Deed
Shah claimed that he was entitled to interest at 3% above base rate, i.e. the rate specified in the agreement before an annual discount of £30,000 agreed by the trustees, on his share of the EBT’s funds that had been loaned back to Insafe. Here the court found that Shah’s entitlement was as a beneficiary of the EBT, as a trust, and so the terms of the trust would govern his entitlement. Shah had been aware of the reduction in the interest rate as it had been referred to in the tax disclosure letters signed by the directors. Again, Shah’s claim failed.

Professional charges- follow the Trust Deed
One might think that professional charges incurred by Insafe in its dealings with HMRC leading to the EBTSO agreement were not the employee’s responsibility but here again the Court found that the professional advisers were acting for Insafe in both its capacity as a company and as a trustee. As the arrangement was explicitly dealt with by the Trust Deed which entitled Insafe to reimbursement from the Trustees for the costs of dealing with HMRC, Shah could not claim that he was entitled to receive earnings without any reduction for the professional costs: he was a beneficiary of the trust and so what he could expect to receive was only the sums available to the Trustees to pay out to him. Shah’s claim failed.

Implications
Mr Shah was Insafe’s Finance Director and a 20% shareholder and as such had a significant stake in the company and will have been aware of the arrangements made in setting up the EBT and the tax disclosure letter. Therefore it may be easy to be less sympathetic to his situation than that of an employee who was not part of the managing mind of the company. But only really in relation to the interest and professional charges: as regards tax and NIC the decision leaves him in a position little different from if he had simply received a bonus. As a director and presumably, and constructively, aware of the EBT arrangements it may seem odd that he should have challenged them later. After all, he was also expecting or hoping to benefit from a significant tax saving, so it seems fair that he should have to take his chances.

However, this does have possible ramifications for EBTs with wider classes of beneficiary (as the case where all of a company’s employees were involved, who may not have had the same level of awareness of what they might stand to lose, if they were aware of the existence of the EBT at all). That is not a tax issue and not one on which we would care to comment but there may be a question going begging there.

For further information contact Chris Williams