Contractor offshore solutions can conjure up images of private bank accounts in exotic Caribbean locations, but the reality is much more straightforward.
The majority of offshore consultancy supply chains for contractors utilise Employee Benefit Trusts (EBTs). These, as the name suggests, have been used for decades to provide tax-efficient benefits to the employees of a company. In fact, one of the major uses of EBTs is to provide a vehicle for workers to own shares in their employer, so, for example, the employees of the John Lewis Partnership use an EBT.
Plus, the vast majority of pension funds in which we entrust our life’s savings have offshore trusts somewhere in their financial structure. The Isle of Man is a highly reputable, secure and compliant offshore financial services centre which provides a highly suitable location for the provision of consultancy supply chain servicing.
How do EBTs work?
The consultancy supply chain provider that manages the contracts and your ‘employment’ is frequently based in the Isle of Man, will employ you and pay you a salary. Your salary is subject to income tax under PAYE and National Insurance Contributions (NICs), all in line with normal UK tax procedures and with full disclosure to HMRC. The company may also make contributions to an Employee Benefit Trust established for the benefit of its employees. The Trustees of such an independent EBT manage the affairs of the trust.
The solution provider takes over contracts with the agency or client, so that contractors are now hired out as employees of the solution provider’s consultancy supply chain. A good solutions provider will give you all the support you’d expect from any other employer, such as a human resources function. It will also provide all the paperwork you would expect as an employee. A further benefit, of course, is that as contractors are employees paying tax via PAYE, IR35 legislation ceases to be applicable.
The crucial difference between a consultancy supply chain provider that offers the opportunity to participate in EBT arrangement and a UK based employer is that the Trustees of the EBT may provide its contractor employees with receipts from the Employment Benefit Trust. This enables contractors to legitimately receive payments with a lesser tax burden; the tax burden would be considerably higher than if they were employed directly by a UK company and in many circumstances more than if they worked through their own contractor limited company.
An important point for contractors to consider is that a legitimate offshore consultancy supply chain, based in the Isle of Man, will be a separate legal entity from the associated Employee Benefit Trust. Depending on the provider, the Trust’s deeds will be written in such a way as to ensure the best interests of the contractor employees are always paramount.
Payments from the EBT
Because receipts from the EBT are in the form of loan, typically interest free, this means a benefit in kind tax (BIK) is incurred. HMRC deems the interest you are not paying as a ‘benefit’ and subsequently worthy of taxation. HMRC publishes a notional rate of interest for this purpose, assessed against your individual tax rate, which if it were set at 6.25%, it would provide an effective BIK tax rate of between 1.1% and 2%.
So, if you received a loan of £50,000 that was outstanding for a full year and the rate from HMRC were 6.25%, then the interest due would equate to between £550-£1000, depending on your personal tax rate. You should receive annual statements from the Trustees calculating the “cash equivalent” (HMRC’s term) of the benefit and the BIK tax liability due and accrued. One final number to consider is the £50,000 received outside of an EBT would cost a higher rate taxpayer £20,000 in tax.
Although the debt will remain outstanding, contractors are highly unlikely to receive a final demand for full repayment: Because it is a fundamental part of the Trust Deed that the Trustees may not at any time act to the detriment of the Employee(s), past, present and future it is difficult to foresee how any such loans may ever be recalled.
Can HMRC put a stop to this?
EBTs are a widely used financial vehicle, they have been in existence for a long time and have a huge amount of entrenched legislation relating to how they can be set up and used. There was also an important test case, Dextra Accessories v Macdonald, where the ground rules for EBTs were laid down and agreed by HMRC, and these rules were confirmed in the Finance Act 2003.
EBTs are a widely used financial vehicle, they have been in existence for a long time and have a huge amount of entrenched legislation relating to how they can be set up and used
Rory Kilmartin, Bedouin Group
In addition, the law says that if a loan is classified as being repayable, then it is not possible for HMRC to reclassify the loan as income and incur tax on the amount. The loan from the EBT that manages its contractor employees’ funds remains an ongoing liability for the contractor and therefore it is not income.
An offshore consultancy supply chain that uses EBTs will suit the needs of some, but not all contractors, just as the limited company or umbrella company options don’t suit every contractor. But consultancy supply chains using EBTs as part of their flexible benefits offering are likely to increase their take-up by contractors during 2010 and they represent a legitimate alternative for contractors thinking of changing the way they run their contracting business.”
Updated: Wednesday, February 23, 2011
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