An EFRBS is an arrangement entered into by an employee and an employer to provide ‘relevant benefits’. These are any lump sum, gratuity or other benefit (including non-cash benefits) paid in respect of:
• Retirement or death;
• In anticipation of retirement;
• After retirement or death in connection with past service;
• On or in anticipation/connection with a change in the nature of the employee’s service;
• As a result of a pension sharing order.
For pension purposes, benefits accrued under an EFRBS do not currently count towards the Annual Allowance, Special Annual Allowance and Lifetime Allowance nor are they subject to the contribution and investment restrictions which apply to registered pension schemes.
EFRBS are typically set up under a discretionary trust to enable maximum flexibility over potential beneficiaries. The UK-resident trust’s tax position is that of the rate applicable to trusts (RAT). Discretionary EFRBS will be subject to the normal inheritance tax (IHT) charging rules, so will be subject to the 10 year periodic and exit IHT charges. Benefits will not form part of the beneficiary’s estate unless and until appointed out to them, in which case the trustees and the beneficiary could potentially claim capital gains tax holdover relief.
Death in service lump sum benefit should not be written under an EFRBS as there is the potential for HMRC to deem this a “gift with reservation” forming part of a member’s estate. This issue can be avoided by having the EFRBS pay widows/dependents/orphan’s pensions instead of paying a lump sum on death.
• Income Tax – no income tax charge arises on the employer contribution. No income tax relief on any employee contributions, so it is preferable to be employer funded.
• National Insurance – no employee NI charge arises on the employer contribution.
• Inheritance Tax – any employee contributions will be treated as a settlement and count as a chargeable transfer.
• Corporation Tax – no relief immediately available. Relief can be claimed via repayment of corporation tax paid once benefits are paid and become chargeable to tax on the employee. In some instances, companies have claimed a Corporation Tax deduction for a contribution to an EFRBS on the basis that this contribution, or a transfer to a second EFRBS, represents a “qualifying benefit” under the terms of the legislation. However, HMRC have stated that, in their view, this is not correct, and will therefore seek to deny a deduction claimed in these circumstances.
• National Insurance – no employer liability for NI on payments made to an EFRBS.
• Pension – taxed as income under PAYE. Payment to an EFRBS therefore represents an Income Tax deferral for the employee, perhaps to a time when they are either non-UK resident, or are paying tax at a lower rate.
• National Insurance – There will be no liability to National Insurance provided employment has ceased and the member is not re-employed by the company. In addition the benefits that are paid out must be in a form that is consistent with that of a registered pension scheme (i.e. lump sum not more that 25% of fund, pension payable at least annual etc).
• Lump Sums – taxed as income under PAYE. Any employee contributions made to the EFRBS will reduce the amount of lump sum subject to income tax.
• Avoids employee NI and employer NI liability
• Provides employees with an uncapped pension and lump sum
• Avoids restrictions associated with registered schemes
• Could be used to make loans to either the employer or employee.
• Can extract profit from the business in a similar way to dividend but with the deferral of income tax on the individual until benefits are paid
• Corporation tax relief deferred until member draws benefits
• No tax privileges
• Investment returns are subject to income and capital gains in a UK based trust.
• Trust subject to IHT periodic and exit charges on funds
• High set up and ongoing administration costs (particularly if run offshore)
• Onward portability is limited i.e. if member leaves employment
• HMRC is viewing these arrangements with suspicion and further legislation is on the way in 2011.
• Offshore EFRBS expose taxpayer to the potential of changing legislation in overseas jurisdiction
EFRBS, if constructed and managed sensibly, represent a useful retirement planning tool for those companies which are seeking to enhance their employees’ remuneration package above the limits available under a registered pension scheme and/or for those employees likely to retire abroad and not return to the UK.
It should be noted, however, that EFRBS’ are complex, and potentially contentious, due to their complexity, their current vulnerable legislative status, and the potential for an offshore EFRBS to interact with foreign taxation.
By Robert I Fraser