Employee bonus schemes using money-box companies
HM Revenue & Customs (“HMRC”) have recently won a case on the tax treatment of an employee bonus scheme which involved employees acquiring shares in “money-box companies” instead of receiving cash bonuses.
Although legislation introduced in April 2003 would prevent the scheme from being successful now, the case provides interesting comment on share valuations and the exercise of discretion by trustees of EBTs.
Under these arrangements, rather than receiving cash bonuses, employees received shares in a company which held a large amount of cash (a “money-box” company). Shares in such a company would normally be very valuable, but in this case a large part of the company was under option to a trustee with a low exercise price, which it was argued made the employee shares valueless and so no tax charge arose for the employees.
What then happened was that the options were deliberately not exercised by the trustees (even though they were valuable) and therefore value flowed into the shares held by the employees – but this transfer of value was crucially argued not to be subject to income tax.
The first tier tax tribunal (the “Tribunal”) held that the scheme was not successful. In particular, the Tribunal held that:
•The scheme involved a series of steps which were intended to operate together to provide additional remuneration from the employer to the employees in a manner that did not give rise to income tax or NICs liabilities. Following the Ramsay principle, a purposive interpretation of the tax and NICs legislation could be taken and as a result the benefits received by the employees should be taxed as if they had received a cash bonus paid directly by their employer;
•Although the options were not shams, they were commercially irrelevant because it was a feature of the scheme that the parties intended that the options would never be exercised. When valuing the shares transferred to the employee, the valuation should therefore be made on the assumption that the options would not be exercised. Accordingly, the shares should be valued on the basis of the (high) net asset value of the money-box company;
•The Tribunal took the view that the trustees involved in the arrangements did not exercise any discretion in relation to them.vAlthough the trusts were real and the trustees had a genuine right to exercise their independent discretion, the trustees did not exercise that discretion. The trustees followed the recommendations of the employer and there was never any question that they would not act in accordance with those recommendations. The trustees had been involved in discussions about the scheme before it was implemented but did not make any positive contribution to those discussions. There was never any doubt that the trustees would not follow the recommendations of the employer and employees elected to participate in the scheme on that basis. The trustees did not appear to consider whether the benefits employees received should be different from those recommended by the employer. Further, as it was always intended that the options would never be exercised and the trustees did not have any information on which to base a decision about exercising the options, it was difficult to see what administrative actions they actually performed.
This case is the latest in a number of recent cases on the operation of employee share schemes which have been found in favour of HMRC. Although such a scheme would not work under current legislation, the case is a further demonstration of HMRC’s willingness to challenge former schemes and to seek to apply the Ramsay doctrine to tax arrangements that have the overall effect of enabling the employee to receive a bonus from their employer.
Although this may not on its own have been enough to change the decision either way, the case highlights the need for EBT trustees to exercise, and be seen to exercise, their independent discretion. In particular, trustees should not be seen to merely rubber-stamp a recommendation from an employer and should carefully consider whether they should exercise their discretion in the way requested. Where appropriate, trustees should request additional information to enable them to make their decisions.
This article first appeared in Law-Now, CMS Cameron McKenna's free online information service, and has been reproduced with their permission. For more information about Law-Now, please go to www.law-now.com