Contractor Employee Benefit Trusts (EBTs), also known as consultancy supply chains, were used as offshore tax solutions that could substantially increase contractors’ net pay. But legislation introduced on 9th December 2010 removed the tax benefits of using such schemes.
EBTs 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 has been to provide a vehicle for workers to own shares in their employer; so, for example, the employees of the John Lewis retail partnership have used an EBT.
How did EBTs work for contractors?
A contractor utilising an EBT would be ‘employed’ by a solutions provider, frequently based in the Isle of Man. The contractor’s salary from the solutions provider was subject to pay as you earn (PAYE) income tax and National Insurance Contributions (NICs), all in line with normal UK tax procedures and with full disclosure to HMRC.
The contractor’s solutions provider ‘employer’ would also make contributions to an Employee Benefit Trust, established for the benefit of its employees. The trustees of such an independent EBT managed the affairs of the trust.
The solution provider took over contracts with the agency or client, so that the contractor was hired out as an employee of the solution provider’s consultancy supply chain. That solutions provider would normally provide all the paperwork expected by an employee. Another key benefit was that, as contractors were classed as employees paying tax via PAYE, IR35 legislation ceased to be applicable to them.
Contractors received ‘loans’ from the EBT
The crucial difference between a consultancy supply chain provider that offered the opportunity to participate in an EBT arrangement and a UK-based employer was that the trustees of the EBT would provide its contractor employees with receipts from the Employment Benefit Trust, usually in the form of an interest-free loan.
This enabled contractors to legitimately receive payments with a lesser tax burden, because the payments were in the form of such a loan. The resulting tax saving would be considerably higher than if the contractor was employed directly by a UK company, and in many circumstances more than if they worked through their own contractor limited company.
The offshore ‘consultancy supply chain’, or contractor employer based in the Isle of Man, would be a separate legal entity from the associated EBT. Also, the trust’s deeds would be written in such a way as to ensure the best interests of the contractor employees were always paramount.
Payments from the EBT
Because receipts from the EBT were in the form of loans, typically interest free, this meant a benefit in kind tax (BIK) was incurred. HMRC deemed the interest that contractors using the scheme were not paying to be a ‘benefit’, and therefore worthy of taxation. HMRC published a notional rate of interest for this purpose, assessed against the contractor’s individual tax rate. For example, if it were set at 6.25%, it would provide an effective BIK tax rate of between 1.1% and 2%.
So, if a contractor received a loan of £50,000 that was outstanding for a full year and the HMRC rate was 6.25%, then the interest due would equate to between £550 and £1000, depending on the contractor’s personal tax rate.
The contractor would receive annual statements from the trustees calculating the ‘cash equivalent’ (HMRC’s term) of the benefit and the BIK tax liability due and accrued. By comparison, a higher rate taxpaying employee being paid £50,000 outside of an EBT would pay £20,000 in tax.
Although the debt remained outstanding, contractors were highly unlikely to receive a final demand for full repayment. This is because a fundamental part of the trust deed of the EBT is that the trustees may not at any time act to the detriment of the employees (ie, the contractors), past, present and future, so it is difficult to foresee how any such loans may ever be recalled.
‘Employment Income through Third Parties’ legislation
On 9th December 2010, the Treasury published draft legislation of an amendment to the Income Tax (Earnings and Pensions) Act 2003, which meant that from that date contractors using EBTs saw their tax bills increase. Called ‘Employment Income through Third Parties’ and designed to tackle ‘disguised remuneration’, the new rules contained anti-forestalling provisions.
The amended legislation treats income such as interest loans from EBTs as employment income, so that it attracts income tax and National Insurance Contributions (NICs) accordingly.
The result of the amendment is that, since 9th December 2010, EBTs ceased to be tax efficient offshore solutions for contractors.