Payments of bonuses into family benefit trust not deductible for corporation tax

15 September 2008

In a bonus planning case the Special Commissioners decided that bonuses paid to a family benefit trust were not subject to PAYE or National Insurance contributions (NICs) and were not deductible for corporation tax purposes.

Sempra Metals Ltd paid annual bonuses based on a percentage of profits to a family benefit trust (that is a trust for the benefit of families of employees but not for the benefit of employees). The trustee kept the money in designated pots and either invested it or lent it to beneficiaries on request. Sempra did not operate PAYE or NICs on the payments to the trust and claimed a corporation tax (CT) deduction for them.

HMRC disallowed the CT deduction and assessed the amounts paid to income tax and NICs. Sempra appealed to the Special Commissioners.

The Special Commissioners held that the payments to the trust were not subject to PAYE and NIC but were not deductible for CT purposes either.

The decision on PAYE and NIC is in line with the case law which establishes that payments must be placed unreservedly at the disposal of employees to be subject to income tax. The beneficiaries of the trust were not employees and had to apply for interest bearing loans to access the funds, the trustee had discretion as to whether to make the loans.

The issue which has always been less clear about these bonus planning arrangements is whether contributions to the trust are deductible for CT purposes. The Special Commissioners found that the contributions were for the benefit of the trade and properly accounted for as an expense so the issue turned on whether Schedule 24 to the Finance Act 2003 denies relief for contributions which are not subject to income tax in the hands of employees.

The family trust arrangement had been specifically designed to avoid Schedule 24 but the Special Commissioners took a wide view of the legislation finding that it was "a trust, scheme or other arrangement for the benefit of persons who are or include present or past employees” even though none of the employees was a beneficiary under the trust. It was enough that employees benefited indirectly from the loans to their families (and directly in some cases where the loans were paid into joint accounts).

Sempra were well advised, they took the precaution of paying only 70% of the bonuses into the trust and kept the rest in case HMRC denied the CT deduction. Most employers that use bonus planning arrangements of this sort will have done the same as it has always been unclear if a CT deduction is available.

If you have any questions about this case or about the tax treatment of bonuses, please do not hesitate to contact the Bird & Bird team.

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