Employee benefits, trusts and tax: Employers beware

12 minutes de lecture
14 janvier 2022

In this article, we highlight some technical tax-related developments that will be of interest and concern to employers with trust-based employee benefit arrangements.

While the underlying law is relatively clear and well-established, there are still a few lesser-known legal risks to which employers are exposed which can lead to unexpected and potentially expensive tax liabilities or other penalties being incurred. Fortunately, those risks can be reduced or even removed completely if appropriate action is taken at the right time.

Below we suggest some solutions that employers could consider adopting.

Key action points for employers

1. Inheritance tax threat to Employer-Funded Retirement Benefit Scheme payments

Employer-funded retirement benefit schemes ("EFRBS") are subject to a quirk of Inheritance Tax ("IHT") law which means that an unexpected and potentially expensive tax charge might arise on the death of a member before their pension is paid.

To help prevent that charge arising, employers should consider taking steps to review their EFRBS' governing terms and, if necessary, amend them to expressly exclude the member's personal representatives ("PRs") from the trust's class of potential beneficiaries.

2. HMRC's Trust Registration Requirement applies to some surprising employee benefits

Employer-funded medical benefit trusts, trusts for surviving minors, EFRBS and other trusts of non-insured employee benefits are all very likely to be caught by HMRC's new Trust Registration Service ("TRS") requirement.

Employers should review their employee benefit arrangements, identify which need to be registered, and take the steps necessary to complete the process before September 2022.

3. Excepted Group Life Trusts to remain subject to inheritance tax rules

Despite a recent HM Treasury review, trusts established to hold excepted group life or relevant life insurance policies remain potentially subject to IHT on each tenth anniversary and on exits in between those anniversaries. Employers who have not already taken steps to manage the risk of those payments arising, or who have any concerns about those steps' effectiveness or suitability, should seek advice on what steps can be taken without contravening tax law.

What employers need to know in more detail

It is an inconvenient but unavoidable fact that different tax rules apply differently to different employee benefit arrangements. What employers need to do to navigate each of them depends on the benefit being provided. Some tax rules, like those for HMRC-registered pension schemes under Finance Act 2004, are complicated but are relatively well-established and understandable by those that are affected by them.

Other rules and arrangements are far less familiar and require more specialised practical know-how, as they contain unexpected and potentially expensive hazards for the unwary.

We highlight three of them here, and suggest some valuable steps that affected employers can take to identify and then deal with them efficiently.

Inheritance tax threat to EFRBS payments

What's the issue?

EFRBSs are retirement benefit schemes that operate outside of HMRC's registered pension scheme rules under Finance Act 2004. They can be funded or unfunded, and usually take the form of a contractual promise by the employer to a senior employee, with benefits provided via a trust set up for that purpose. HMRC's separate "disguised remuneration" rules have limited the number of EFRBS set up since 2011, but many employers still have old EFRBS trusts in place, awaiting the retirement of the named employee member.

The age of those trusts can often lead to them being overlooked - particularly if the employee they relate to has since moved on. Do you know if you have any EFRBS trusts waiting to be put into payment? After lying dormant for many years, an increasing number of EFRBS payments are now being triggered by the death of the member before having reached their retirement age.

EFRBS will usually be written as discretionary trusts. This is intended to help ensure that any death benefits that become due from them to be paid out as a lump sum free that is of IHT, and most employers and members will reasonably assume that will apply to their own EFRBS in all cases.

However, a quirk of tax law and practice means that this is not an automatic result. Unregistered schemes such as EFRBS are subject to HMRC's 'gift with reservation' ("GWR") rules and so may still be subject to IHT. Where the class of discretionary beneficiaries under the trust includes the member's PRs, the resulting payment can attract IHT, even if the benefit is not actually paid to those PRs.

This result is likely to be contrary to the employer's expectation, and contrary to the interests of the member and their estate. It may also be contrary to the contractual promise agreed with the member when they were an employee, making it a material source of uncertainty and financial risk to the employer.

What's the solution?

Mitigating steps may be possible before the death of the member. To avoid a potential inheritance tax charge on the deceased member's estate as a result of a GWR having been created, it is prudent to expressly exclude those PRs entirely from the class of potential beneficiaries under the EFRBS. This removes the potential for the conferment on them of that death benefit.

The trust and contractual terms of the EFRBS should be checked as a first step and, where it is legally possible to do so, a formal amendment to the member's class of potential beneficiaries should be agreed.

As it will be too late to rectify the matter after the member has died, it would be prudent to identify affected schemes and take any necessary remedial steps as soon as possible.

We can carry out that check as a priority, advise you on the risk of an IHT charge arising and, if necessary, prepare amending documentation for you to agree with the member.

HMRC's Trust Registration Requirement applies to some surprising Employee Benefits

What's the issue?

Following reforms made to the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (the "AML") in 2020, many forms of express trust became required to register with HMRC via its TRS - even if they are not subject to tax. The TRS was finally made active in September 2021.

Conveniently, pension and life assurance scheme trusts that are already registered with HMRC under Finance Act 2004 rules are exempt from the requirement. So are other forms of insured benefit provision, such as trusts set up by employers solely to hold excepted group life, relevant life or critical illness policies.

However, there are still some forms of employer-settled trust that are very likely to be caught by the new requirement.

  • One notable example is employer-funded medical benefit trusts for employees. Despite efforts made during the AML's consultation phase, and despite them being at very low-risk of being used as a money-laundering vehicle, HMRC didn't grant these trusts a specific exemption. There is a possibility that they could be granted that exemption later in 2022, but for now, employers who fund healthcare benefits for their staff through a trust (or participate in a master trust product for that purpose) should make enquiries about the steps that need to be taken to comply with the TRS requirement.
  • Another example that could still affect employers with exempt pension schemes is the use of a separate survivors' trust. These are sometimes established by employers or pension scheme trustees where, for example, the main scheme needs to pay out funds held in respect of a death benefit before the expiry of a two-year period, or (except in certain very limited circumstances) where a trust is established for the benefit of surviving children.
  • Other trust-based arrangements provided employee benefits, if they are not fully insured.

The obligation to register rests on the trustees, not the employer, but in the case of many non-pension benefit schemes it is often the company that takes on the role of sole or co-trustee, so the matter is still of practical relevance to employers.

HMRC has provided detailed guidance on the registration process and registration must be applied for via HMRC's on-line portal.

Express non-taxable trusts must register:

  • where they were in existence on or after 6 October 2020, by 1 September 2022;and
  • where they were created after 1 September 2022, within 90 days of their commencement.

What's the solution?

Employers should check the registrable status of the trusts through which they provide employee benefits and make arrangements to have them registered before September.

Excepted Group Life Trusts to remain subject to inheritance tax rules

What's the issue?

It has long been a source of frustration that, while group life assurance schemes registered with HMRC under Finance Act 2004 enjoy a concession that exempts them from ordinary IHT rules, unregistered schemes (as "relevant property trusts") do not. This means that the increasingly popular decision to use trusts holding excepted group life and relevant life policies as an alternative to traditional HMRC-registered group life cover exposes those trusts to the risk of chargeable transfer, ten-year anniversary and exit charges being imposed under inheritance tax law.

Various measures have been adopted by employers over the years to attempt to reduce the likelihood of such charges arising, although the commonest of those (the use of a short trust period) has some practical as well as legal limitations that puts its effectiveness in doubt.

A recent review by HM Treasury's Office of Tax Simplification offered a chance to remove the inconsistency and make unregistered schemes IHT-exempt. Unfortunately, despite lobbying from the industry, when the OTS's conclusions were published in November 2021, they failed to recommend the necessary change.

What's the solution?

For the time being, the chargeable transfer, periodic and exit charge rules will continue to apply to excepted group life and relevant life trusts. Employers who have any concerns about the effect of those rules on the benefits to be paid from their life assurance trusts, or the effectiveness of any strategies recommended to them for the mitigation of any IHT changes that might become due, should seek professional advice.

CECI NE CONSTITUE PAS UN AVIS JURIDIQUE. L'information qui est présentée dans le site Web sous quelque forme que ce soit est fournie à titre informatif uniquement. Elle ne constitue pas un avis juridique et ne devrait pas être interprétée comme tel. Aucun utilisateur ne devrait prendre ou négliger de prendre des décisions en se fiant uniquement à ces renseignements, ni ignorer les conseils juridiques d'un professionnel ou tarder à consulter un professionnel sur la base de ce qu'il a lu dans ce site Web. Les professionnels de Gowling WLG seront heureux de discuter avec l'utilisateur des différentes options possibles concernant certaines questions juridiques précises.