Macdonald (HMIT) v Dextra Accessories Ltd & others

In a unanimous verdict, the House of Lords have upheld the decision of the Court of Appeal in favour of the Inland Revenue in the case of Macdonald (HMIT) v Dextra Accessories Ltd & Others.

What were the facts?

Dextra Accessories Ltd and 5 other group companies made contributions to an Employee Benefit Trust (EBT), set up by the holding company of the group. They deducted these contributions in computing their taxable profits for the accounting period in which the contributions were made.
The trust deed gave the trustee wide discretion to pay money and other benefits to beneficiaries and a power to lend them money. The potential beneficiaries of the trust included past, present and future employees and officers of the participating companies in the Dextra group, and their close relatives and dependants.

The trustee did not make payments of emoluments out of the funds in the EBT during the periods concerned, instead the trustee made loans to various individuals who were beneficiaries under the terms of the EBT.

What was the point at issue?

The question was whether the companies’ contributions to the EBT were “potential emoluments” within the meaning of section 43(11)(a) Finance Act 1989, being amounts “held by an intermediary, with a view to their becoming relevant emoluments”.

What was the decision?

The House of Lords held that the contributions by the companies to the EBT were potential emoluments within section 43(11)(a) as there was a "realistic possibility" that the trustee would use the trust funds to pay emoluments. The Court of Appeal, agreeing with the High Court, had said that it was "rightly accepted" that the trustee was an intermediary. “With a view to” did not mean the sole purpose (as the Special Commissioners had held) or the principal or dominant purpose (as the High Court had held).

This meant that the companies’ deductions were restricted. The companies could only have a deduction up to the amount of emoluments paid by the trustee within nine months of the end of the period of account for which the deduction would otherwise be due. Relief for the amount disallowed will be given in later periods of account in which emoluments are paid.

Is the case of wider interest?

The case is of wider importance as contributions to EBTs have been a feature of a number of marketed tax avoidance schemes. The treatment set out below sets out the HMRC view of when relief is available, in light of this decision, for contributions to EBTs before the introduction of Schedule 24 Finance Act 2003.

What EBTs will be affected?

The decision applies to all EBTs where there is a "realistic possibility" under the terms of the trust deed that funds will be used to pay emoluments, however wide the discretion given to the trustees.

It does not apply to contributions made on or after 27/11/2002, which would otherwise be deductible for periods ending on or after that date. Relief for these is governed by Schedule 24 Finance Act 2003.

What are emoluments?

HMRC accept that the term "emoluments" for the purposes of section 43 is wider than just taxable emoluments. It includes money and other benefits convertible into money, even if there is no tax charge at that time the payments are made by the trustees, for example as a result of a statutory exemption.

A loan to a beneficiary is not an emolument. It is simply an investment made by the EBT. At some point the loan will have to be repaid and the money will then be available to the trustee to disburse in line with the terms of the trust (which is likely to be in the form of emoluments).

Will this cause anomalies?

In his judgement Lord Hoffman accepted that this interpretation could lead to some employers never obtaining relief. He went on to agree with the comments of Jonathan Parker LJ in the Court of Appeal, saying that "it is the result of an arrangement into which the taxpayers have chosen to enter."

What will HMRC be doing?

The Anti-Avoidance Group has set up a team to project manage these other cases to ensure that the tax outstanding is collected systematically and consistently.

In appropriate cases, HMRC will be issuing closure notices in cases under enquiry, disallowing contributions where emoluments have not been paid.

Updated Guidance:

HMRC will be reviewing the guidance in the Business Income Manual on EBTs and other areas affected by section 43 Finance Act 1989. Where appropriate, the guidance will be updated to reflect the decision in this case.

Implications for Inheritance Tax (IHT)

Where the company making the contributions to an EBT is a close company, the outcome of this litigation is likely to have implications for IHT.
The effect of section 13 Inheritance Tax Act 1984 (IHTA) is that an IHT charge under section 94 IHTA on transfers of capital by a close company will arise where:

• a close company transfers capital to an EBT which satisfies s86IHTA;
• the participators in that company are not excluded from benefit under the EBT, and
• the contributions are not allowable in terms of section 12 IHTA in computing its profits for CT purposes.

In these circumstances the transfers of capital by the company will be transfers of value for IHT purposes.
In terms of section 94 IHTA, HMRC then look through the close company and apportion the transfer of value between the participators "according to their respective rights and interests in the company immediately before the transfer". Any IHT charge therefore falls on the participators as individuals and will be at the current lifetime tax rate of 20% rising to 40% in the event that the participator dies within 3 years of the transfer (section 7 IHTA).