EFRBS are essentially company sponsored trust arrangements designed for individuals who wish to accumulate retirement benefits outside a registered pension scheme. They were originally introduced to allow employers to compensate employees who were subject to the earnings cap in their approved occupational pension scheme or employees who wish to pay into a pension scheme while working overseas. Following the A day changes to pension regime, these types of schemes are now generally known as EFRBS. The range of uses of EFRBS in practice has grown, some of these being more aggressive than others. This has resulted in HM Revenue & Customs ('HMRC') keeping a watchful eye on them.
Tax treatment of EFRBS
An EFRBS is not a registered pension scheme. Registered pension schemes qualify for a number of tax advantages: companies can claim corporation tax relief for contributions to registered pension schemes, and the income and gains of registered pension schemes are exempt from tax.
Although EFRBS arrangements are not registered schemes and do not benefit from these tax advantages, the employee does not have to pay income tax or National Insurance Contributions ('NICs') on contributions by a company to an EFRBS, and the company does not have to pay employer's NICs. There is generally no corporation tax deduction on the contribution made into an EFRBS until such time as an employee draws a taxable benefit from the EFRBS. Although an EFRBS is not a tax exempt structure, if an EFRBS is set up offshore, there will be no UK tax payable on income and gains, so to that extent the EFRBS will be in a similar position to a registered pension scheme.
The government has announced restrictions on tax relief for pension contributions for high earners with effect from April 2011 (with anti-forestalling provisions which are already in place). After April 2011, only those earning less than £150,000 will get full higher rate tax relief for pension contributions. For those earning between £150,000 and £180,000 there will be a sliding scale of tax relief, and for high earners with income above £180,000, tax relief will be restricted to the basic rate only. Against that background, using an EFRBS as an alternative to or in addition to a registered pension scheme may make a lot of sense for high earners.
A big advantage of EFRBS arrangements over registered schemes is that EFRBS do not have any investment restrictions and therefore they are much more flexible than registered schemes. This means that an EFRBS can provide very flexible benefits to members. They can also be used to effect transactions with connected parties (such as trustees or scheme members provided these transactions are on a commercial basis).
In general, an EFRBS can invest in stocks, shares, loans, (including loans to the employer company and employee), and commercial as well as residential property. In fact it can invest in anything an individual can invest in personally.
Some advisers have been more aggressive in their tax planning and found ways to try to secure a corporation tax deduction for contributions to "double EFRBS" arrangements by relying on various arguments that a taxable benefit has been provided to employees. It is clear that HMRC intend to close this loophole as they have included EFRBS in their anti-avoidance 'spotlights'. HMRC's list of spotlights identifies specific schemes which in their view are not likely to deliver the tax savings advertised. Where they see such schemes being used, they will make a challenge and seek to ensure full payment of the correct amount of tax.
It has also become relatively common for advisers to suggest the use of an EFRBS to extract cash from a company in a tax efficient way. The idea is that the company sets up an EFRBS for the benefit of a particular employee and makes a contribution. No PAYE or NICs are paid on the contribution. The EFRBS then makes a loan to the individual at a commercial rate. Although the company would not get corporation tax relief for the contribution and the individual has to meet the interest on the loan, it may be a more tax efficient way for an employee to extract cash.
Similarly if a company intends to invest in an asset where a capital gain is potentially going to arise in the future, it may be more tax efficient for the company to contribute to an EFRBS which would invest in the asset, and make it available to the company. This would avoid a tax charge on the eventual sale of the asset. It remains to be seen whether these types of arrangements could find themselves in the Revenue spotlight in the fullness of time.
In summary
EFRBS have a number of benefits which registered pension schemes cannot offer, and may be extremely beneficial as an addition to registered pension arrangements. However HMRC are looking at the more aggressive uses of EFRBS structures.
Contributor
Director of Corporate Tax
