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YOUR REF:
OUR REF:
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DOC ID:
7389920
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kulsoom.hadi
@traverssmith.com
26 November 2008
Dear Sirs
Tax Law Reform 2007/8
Extra-Statutory Concession D35
We write in relation to Extra-Statutory Concession D35 “Employee Trusts: Transfers of Assets to
Beneficiaries” (“ESC D35”). We note that the concession is included in the HM Revenue & Customs
document “Extra-statutory Concessions – Technical consultation on draft Legislation” dated 3 November
2008. This sets out the concessions that are to be put on a legislative basis following the decision in R v HM
Commissioners of Inland Revenue ex p Wilkinson (2005) UKHL 30 and includes the drafting necessary to
achieve this. We have certain technical comments on the proposals but the most important comment is that
some modifications should be made to the proposals to render them properly effective and increase the use of
UK based EBTs. We believe that if these modifications are not made enacting D35 in its current form will
mean that EBTs continue to be largely established and run offshore.
Background
ESC D35 concerns employee benefit trusts (“EBTs”) which are discretionary trusts established for the benefit
of employees and certain of their relatives. Section 17 Taxation of Capital Gains Act 1992 (“TCGA”) treats
certain disposals as having been made at market value for capital gains tax purposes. One such circumstance
is where a disposal is made in consideration for an employee’s services. Accordingly, when the trustee of an
EBT transfers an asset to a beneficiary it is generally deemed, by virtue of s17, to have received an amount
equal to its market value. This is irrespective of whether any sum has been paid or is payable for the asset in
question. In most circumstances the beneficiary will have a corresponding income tax charge on the market
value of the asset received from the trust. This effectively leads to a double tax charge.
The Effect of D35
Historically HMRC did not seek to charge the trustee to capital gains tax in such circumstances and, with
effect from 5 December 1990, the approach was formalised in the form of ESC D35. ESC D35 applies where
the trustee of an employee trust (within the definition of section 86 Inheritance Tax Act 1984 (“IHTA”) but
without the restriction in subsection 3 of that section) transfers an asset to an employee who, in turn, is liable
to income tax on the full market value of that asset. In such circumstances the trustee will not be charged to
capital gains tax on any gain arising on the transfer. This is subject to the proviso that the employee must not
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30 December 2008
be a person of the kind described in section 28(4) IHTA (unless he is excluded by subsection (5) of that
section). Broadly this excludes present, past and potential holders of 5% or more of the company’s shares
and persons connected with such individuals. The concession also does not apply in circumstances where the
trust already benefits from special treatment that might relieve the capital gains tax or income tax liabilities
that would otherwise arise.
The Proposed Draft Legislation
The draft legislation to enact ESC D35 set out in the consultation document is, of necessity, more detailed
that the concession. For example, whereas the concession referred only to situations in which “employees”
are liable to income tax, the draft legislation specifically refers to “beneficiaries” that are liable to income tax.
The draft legislation also helpfully refers to “deemed disposals” under section 71(1) which applies where a
person becomes absolutely entitled to settled property. It also clarifies that relief is available where disposals
are made for more than market value. One area where there appears to be a discrepancy between the
concession and the draft legislation is in the definition of “excluded persons”. ESC D35 defines “excluded
persons” by reference to section 28 (4) IHTA. Section 28(4)(b) refers to persons who are participators in any
close company that has made a disposition as a result of which property became comprised in the settlement.
It goes on to provide that the disposition must be one which, but for section 13 IHTA, would be a transfer of
value. By contrast, the draft legislation does not refer to the requirement for the transfer to have been a
“transfer of value”.
Modifications to the Draft Legislation
The concessionary treatment in ESC 35 has been very welcome in preventing double taxation, however, it has
not done so comprehensively. One important area where ESC D35 does not apply is when shares are sold to
beneficiaries at an undervalue rather than transferred for no consideration. An example of this is where an
EBT has subscribed for shares at their nominal value using a loan facility provided by the company. The
shares are then transferred to employees as part of an employee share ownership plan. In order to repay the
loan from the company the EBT sells the shares under the terms of the plan to employees for nominal value.
The employees suffer an income tax charge on the difference between the market value of the shares and their
nominal value. ESC D35 cannot be applied to prevent the EBT from suffering a CGT charge because
employees do not pay income tax on the whole of the market value of a share. This often prompts companies
to incur the expense and administrative burden of establishing their EBTs offshore.
As a matter of policy it seems appropriate to prevent double taxation when assets are transferred by EBTs to
beneficiaries, irrespective of whether any sum is paid for the asset. Clearly if the trustee receives a payment
this may give rise to a capital gains tax charge on general principles if it exceeds the trust’s base cost in the
asset. The consideration would not therefore escape tax. Further, where an EBT trustee grants options to
employees, section 144ZA TCGA operates to remove any deemed market value charge arising on the transfer
of shares. This applies even though an exercise price is paid for the shares. It seems inconsistent for the
capital gains tax treatment to differ according to whether the transaction is structured as an option or a
straightforward asset transfer.
In light of the above we believe that the proposal to put ESC D35 on a legislative footing presents an ideal
opportunity to remedy this inconsistency which, at present, forces companies to incur unnecessary expense
and administration and we hope this opportunity would be taken.
Yours faithfully
R J Stratton
Tax Law Committee, The Law Society