Trading Company in a Trust - ERS issue?

Trusts Discussion
1

Say an individual P holds 51% in a trading company personally, with the other 49% held in a discretionary trust created by his father.

The trustees (P and his sister) now want to appoint the remaining 49% to P absolutely and collapse the trust.

One would think that this will be a simple s260 claim and a 100% BR in relation to the exit.

However, as P is an employee of the company, and the trustees are not “an individual”, it would appear that s421B ITEPA 2003 deeming provision would invoke the ERS rules and thus result in income tax charge on the appointment.

SC decision in [2023] UKSC 37 somewhat upheld this absurd position, albeit in relation to s471, which is not exactly relevant here, but I wonder if there is anything that can ensure the client is not inadvertently triggering a 45% charge on an innocuous appointment of shares in a family company?

2

I don’t think that is quite right.

I’ll assume that P was a director/employee of the trading company when the 51% was acquired so it is clear that P’s own shares are ERS. Also, if I was thinking the employment income tax charge through, I would do it in the following order:

  1. General earnings - s62 ITEPA
  2. Disguised remuneration - Part 7A ITEPA
  3. ERS - Part 7 ITEPA

The normal earnings charge only applies where someone gets profits by reason of their employment. ERS does not come into that bit. So the key question is why is P getting the shares. If it is because P has done really well and deserves to be rewarded then yes, it’s earnings under s62 ITEPA 2003. But it the quantum (49%) and the discretionary trust created by father bit suggests its more family-related and so not by reason of employment.

So then you have to look at the disguised remuneration rules in Part 7A ITEPA. As described / assumed, it won’t get through the gateway in s554A(1)(c) if it is a family discretionary trust as it is not “reasonable to suppose that, in essence … the relevant arrangement … is (wholly or partly) a means of providing, or is otherwise concerned (wholly or partly) with the provision of, rewards or recognition … in connection with A’s [your P’s] employment … with B [the trading company]”. If the family discretionary trust was not to be a family trust but an an EBT (e.g. because you’ve wanted to take advantage of an IHT exemption for employee trusts), disguised remuneration would apply.

Then you get into the ERS rules. Just because a share is an ERS does not automatically mean that there is an income tax charge. For example, if I worked for Tesco and bought a share in Tesco in my GIA in the normal way it would be an ERS but there is no tax charge anywhere.

You could be in Chapter 3C or Chapter 5 of Part 7. None of the other chapters will create a tax charge. Assuming P has no right to acquire the shares (e.g. a call option) then Chapter 5 (securities options) cannot apply. Chapter 3C could apply though. If it does, the market value of the shares (less any price paid) is treated as an interest-free notional loan for the BiK rules (but not for s455). As it’s a trading company, the BiK would be a non-issue as it would be a “qualifying” notional loan. So (if Chapter 3C applied) there would be no tax due until the shares are disposed of. Then the notional loan is treated as being written off and subject to employment income tax, unless to an associated person (see s421C) or P dies (s446U(4(b) - there is no tax on death).

So it would be painful if Chapter 3C applies and P later wants to do something with the shares before death. But if the shares are all the same class then the company will be employee controlled, and this is not being done for the main purpose of avoiding tax, so s446R will give an exemption from Chapter 3C. End of story, no tax charge.

If you trust some random stranger on the internet and the facts I’ve made up are correct then Chapter 3C does not apply and there is nothing else left to create an employment income tax charge.

3

I’d suggest the outcome is does ERSM20220 apply or not? It would appear not.

However - ITEPA 2003, s 62 in relation to the acquisition provided no employment reward is involved.

Is there a genuine employment reward involved?

Richard Bishop

4

Yes, the exemption at the end of s421B(3) is designed to apply to family arrangements (as explained in ERSM20220) but “in the normal course of the domestic, family or personal relationships of that person” is, in my view, too much of a push for HMRC in relation to the trustee of a discretionary trust.

The policy and technical people at HMRC have to consider whether they can really squint at the trustee of a discretionary trust and determine that a trustee is the right kind of trustee (i.e. of a very friendly, family orientated kind of trust) or the wrong kind of trustee (e.g. of an EBT). I doubt if they would be happy saying that.

If you removed the “why” the value went in to the trust in the first place, there is very little difference in the decision of the trustee of a family trust or an EBT to allocate assets of the trust to a beneficiary of a trust, especially as they may both (e.g. in EFRBS or a sub-trust of an EBT) be defined by their relationship to a named individual.

If there is genuine employment reward involved, the ERS point is a non-issue as s62 (or Part 7A) would tax it anyway.

5

Thank you @Tigs and @Bish

For clarity, there is no reward at all in point in this instance, the family is effectively trying to simplify their overall affairs.

The trustees are P and his sister.

The question is, could HMRC take a stance that the deeming provision applies purely on the basis that s421B(3) only disregards transfers by individuals, which trustees are not - but ultimately it is very much a family trust with no intent to reward the beneficiary for his work.

6

If you had asked me in 2003 or 2014, I would have been very confident that the HMRC “owners” of the ERS legislation would have been happy to have a call to chat through the facts, the officer would say “it was probably not the intention of the legislation that such situations should be caught”, you would send a follow up email setting out the facts and the officer would confirm that it was all ok.

Since around 2014, HMRC’s people have got a lot more cautious with things that might be used against them in the disguised remuneration context. I’ve had situations where experienced counter-avoidance people have said something is fine only to say that the disguised remuneration technical owner has said no because it could be used against HMRC. Now ERS is very different to disguised remuneration and whether something is an ERS would make a tiny difference but there are some similarities. In addition, the ERS definition is used with income-based carried interest and so a “no, it’s not an ERS” would probably upset some asset managers.

You could do a non-statutory clearance on this but my concern would be that would get rejected because you’d have to set out what the uncertainty. And don’t forget that Vermilion started with (1) a phone call to the agent where it was said “it was probably not the intention of the legislation that such situations should be caught”, (2) a non-statutory clearance that got rejected, and (3) an employer compliance enquiry.

On the individual point, you would want to be able to show that s421B(3)'s reference to family arrangements and that it being quite silly that your situation means that the shares are ERS gets you within the “(except where the context otherwise requires)” part of s472(1) ITA 2007. To me that’s possible but I have no experience of this.

On the “A right or opportunity to acquire securities … made available by a person’s employer, or by a person connected with a person’s employer”, s993(3)(c) ITA 2007 would seem to say the the trustees are connected with the company so that doesn’t help.

I also want to walk back on the comments I made about the s446R exemption. If the shares owned by your P are ERS then it doesn’t seem to apply. The trust would need to have a different class of shares and P’s shares would need not to be ERS for it to apply. So I’m not be at all helpful here.

7

I agree with @Tigs - we have stopped using non-statutory clearance as the standard reply is “we feel this is tax advice . . . therefore . . read the caselaw”. Not very helpful. And you’re flagging the issue.

‐–‐-----

“The question is, could HMRC take a stance that the deeming provision applies purely on the basis that s421B(3) only disregards transfers by individuals, which trustees are not - but ultimately it is very much a family trust with no intent to reward the beneficiary for his work”.

On the basis HMRC are “flexible” I cannot see how a simple share restructuring placing the director in the same position would require ERS to be inforced.

Is canceling shares (in trust) and reclassify as a different class of shares an option?

Richard Bishop

8

Happy New Year Everybody!

I have tried entirely unsuccessfully to interest anyone in the sillier consequences of the SC decision in Vermilion. Every bonus and cheap rights issue of a private company is now caught by the ERS rules and Chapter 3C of ITEPA. The get-out in s421B(3) and s471(3) does not apply unless an individual makes the right/opportunity available. HMRC do not seem to consider that this extends to an individual using his shareholding votes to cause a company to do the business. ERSM20215 and 20220.

Coupled with the associated persons rule this shows the absurd nature of very wide fictional deeming provisions in statutes. Also the limitations of our case law jurisprudence which means judges do not take notice (“cognisance” as they like to say) of the most obvious unintended consequences. As ever the gross hypocrisy venality and stupidity of HMRC is manifest because they know perfectly well what those unintended consequences are so it’s deliberate unconstitutional warping of legislation by stealth.

Jack Harper

9

And happy new year to you too Jack! I’m glad that the joys of such a wonderful spring day have not jaded your enthusiasm for tax.

In relation to: “Every bonus and cheap rights issue of a private company is now caught by the ERS rules”. That has pretty much always been the case since the new rules came in in 2003 - s421D(2) ITEPA 2003. I guess the exception would be if, say, someone had some shares that were not ERS and then, before the rights issue, became a director. Post-Vermillion most would say that those new shares would be ERS. But I would have said that they would have been ERS before then because of s421B(3).

In relation to: “Every bonus and cheap rights issue of a private company is now caught by … Chapter 3C of ITEPA”, Chapter 3C would need to be tested but that would normally give a £nil notional loan because of s421D(3). This is because that sub-section says that the reduction in the value of the original shares is treated as being consideration paid for the new shares. There will be exceptions to this £nil amount where, for example, people try to shift value by having someone not take up their discounted rights issue.

10

In some cases the company’s share structure may come to the rescue. s446R applies to Chapter 3C but ss429, 443 and 449 apply to other Chapters.

A The first exclusion is where “, at the time of the acquisition of the employment-related securities, the company is employee-controlled by virtue of holdings of shares of the class”. s421H explains what this means. A complication in applying the test is: “employee” includes a person who is to be or has been an employee". Employee includes a director: s5. Some family companies will have many shareholders who are directors or employees.

B The second exclusion is where: “the majority of the company’s shares of the class are not employment-related securities.” Some family companies may have many shareholders whose shares were not acquired as ERS.

A problem in each case is the reference to “class”. Often there will be more than one class and voting may differ as between classes. In A votes and cognate rights seem to be crucial for control as defined in s995 ITA 2007. In B votes etc seem not to matter. How to apply this to a multiple class share structure e.g. alphabet shares? How to test whether a person “is to be an employee” and how long is “has been”?

Finally s446IA disapplies these exclusions in prescribed cases, all within Chapter 3A.

The exclusions seem rather happenstance to me. ERSM20290 just repeats what the statute says so not guidance at all.

Jack Harper

11

Unfortunately, the exemptions were not happenstance but were:

(i) initially drafted by cynical people at HMRC who were not cynical enough, and

(ii) then tightened when HMRC found out about the DB/UBS tax dodging scheme that specifically used the original version of the s429 exemption to escape NIC/IT (this is the scheme that the Supreme Court said did not work).

In relation to: “Finally s446IA disapplies these exclusions in prescribed cases, all within Chapter 3A.” - I think you can forget that bit.

Chapter 3A is a weird piece of legislation that should be abolished as it serves no practical purpose.

It was designed to deal with the “adjustable options” NIC avoidance scheme that tried to take advantage of the April 1999 change from (i) NIC only being due on the discount on the grant share options, to (ii) NIC being due on the gain on exercise. There were different “adjustable option” schemes but the one that Chapter 3A was concerned about worked by reducing the value of the shares (held by an EBT) immediately before the employee exercised. This ensured that the gain on the option was equal to the value of the bonus that the bank wanted to give to the employee in the latter year. As the options had to have been granted before 6 April 1999 and would have had a ten year expiry date, they have all ended a long time ago. So Chapter 3A belongs in a museum rather than the Yellow Book.