How EBT’s Work – and How They Go Wrong – the Melchester Rovers Debacle

Suddenly the acronym EBT is front and centre in the sporting news, leading some to speculate that a decision from the Tax Tribunal dealing with the appeal against tax assessments by Rangers is imminent.

I have therefore, in an effort to clarify and explain the matter to new readers, taken a post I wrote in January and revised and extended it. It also has Roy Race and Melchester Rovers in it.

I should declare that neither the famous footballing hero, Mr Race, nor his world-famous club, are accused of wrongdoing by me. They merely provide a hypothetical example. In addition, I refer to a Mr Waxendale-Balker. He should not be taken as having any connection to a tax expert called Mr Baxendale-Walker.

Now, on with the explanation.

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Who would have thought that the initials EBT would become so common in football discussions? The Employee Benefit Trust was a mechanism used by some businesses to pay their employees and contractors in a “tax efficient” way.

Put very simply (as this is a very complex area) the employer set up or contributed to a separate, arms-length, Trust. Often these Trusts would create separate “Sub-trusts” from which payments were made.

Legitimate use of an EBT allows employees to approach the Trustees for a loan or similar payment. As long as this payment could not be identified as a contractual right, (ie what HMRC refers to as “disguised remuneration”) then the recipient did not need to pay Income Tax and National Insurance on it. In addition, the employer did not need to pay the Employers’ National Insurance contribution either.

To make a scheme legitimate therefore, the following were advisable, if not essential.

1                    There would need to be no evidence of the employee having an entitlement to anything from the EBT.

2                    It would be prudent if, every so often, the Trustees were to reject an employee’s application for funds.

The “loans” to the beneficiaries of the trust would be non-repayable or repayable on such lengthy terms that they were in fact never to be repaid. The jargon term used was “lend and forget”.

In the late 1990’s there was a surge in the use of these EBT’s. Many were marketed by a company owned by Paul Baxendale-Walker. Mr Baxendale-Walker is a former solicitor who, earlier this year bought “Loaded” magazine.

He has, according to the Guardian – “a variety of business interests including a tax consultancy and a soon-to-launch gluten- and lactose-free restaurant called The Treehouse, complete with an “electronic crèche” for children. Companies House records also show that he funds movie, TV and music ventures, including financing Peter, a film about the Yorkshire Ripper, Peter Sutcliffe.

He also owns Bluebird Productions, which makes hundreds of X-rated movies, a number of which he directs and even occasionally stars in. “I make adult films; some people use the word porn. I don’t mind – the content is what it is.”

Mr Baxendale-Walker, respected author of a number of legal and tax-related text books

He literally “wrote the book” on the topic of EBT’s with eminent tax QC Andrew Thornhill, who will re-appear below.

Mr Baxendale-Walker has some extreme views on tax. As he said in a BBC Money Programme episode in 2006:-

“I’m actually helping to cure people of various ills, various cancers,” says Mr Baxendale-Walker. “Because tax is a cancer that will kill your business if it’s not treated. So I see myself as a doctor too.”

 

The doctor will see you now…

A Fictional and Fictitious Example

It is often best to look at an example to see how the scheme might work, and how it could have gone wrong.

As an example of the benefits, let us take a football team – Melchester Rovers. The manager, Roy Race, has decided that his team needs an influx of top quality players. Sir Sam Barlow, the Chairman, is conscious of the need to pay economic wages. How can this be done?

Playing for the jersey, or playing for the pay cheque?

Sir Sam, who made his fortune in the international liquorice markets, meets a legal whizz kid called Mr Waxendale-Balker who extols the virtues of the scheme to him. Sir Sam signs up Melchester Rovers for one of these “off the peg” schemes – the “Melchester Rovers Tax Efficient Trust” is set up, and he goes shopping for players, after having paid Mr Waxendale-Balker’s firm a lot of money to “buy” the scheme.

Sir Sam is a wily businessman. You do not get to the top of the international liquorice trade without being smart enough to judge what places prefer black liquorice and what the red.

“I have bought the tax scheme from the exotic Me Waxendale-Balker,” he says. “I have also bought his book. Why do I need to pay him year after year to run the scheme?”

Sir Sam has a brainwave. He decides that his own company will “sell” the operation of the EBT scheme to Melchester Rovers, and for twice what he paid Mr Waxendale-Balker for it, each and every year! More money for his main business and greater losses for Melchester Rovers which, as mentioned below, does not bother him!

Sir Sam sits down with the Signor Clemenza, the agent for a couple of Italian star players. They each want paid £1 million per year to sign for Melchester Rovers, and, as Ruud Gullit is reputed to have told Ken Bates regarding his salary demands when Chelsea manager, it is to be paid “netto”.

Sir Sam quickly works out that, to pay each player £1 million “netto” it will cost Melchester Rovers around £1.75 million each, taking account of tax and NI.

But Mr Waxendale-Balker’s scheme gives the answer.

If each player, Luigi and Roberto, has a contract which pays him £200,000 per annum gross, then the tax and National Insurance payable on this, including the employer’s contribution, will be around £110,000. If it is agreed, with a nod and a wink, that the players will each be able to receive around £900,000 per annum from the Trust as “loans” which will never be repaid, then Melchester Rovers have just saved themselves almost £1.5 million per annum in tax and NI, and Luigi and Roberto each are getting their £1 million “netto”.

As the payments to the Trust by Melchester Rovers do not count as wages, then they do not reduce the profits, and therefore might lead to an increased liability for Corporation Tax, but, as Melchester have lost millions of pounds over the years in the pursuit of success, they have huge accumulated losses to set against any profits, and therefore that consideration is irrelevant. In fact Sir Sam Barlow has been able to apply some of the losses arising from his company’s ownership of Melchester Rovers to reducing the tax liabilities of Barlow International Liquorice PLC.

There is only one problem with the plan. Clemenza is not stupid. How, he asks, will his players be assured that they will be given the “loans” and more importantly, what if the Trust asked for them to be repaid?

Here Sir Sam makes the fatal mistake. He, along with Roy Race, Blackie Gray and other executives, have already been benefiting from the Trust. As the Trustees are their best friends from the golf club, and as Sir Sam is a Trustee of other schemes run by his friends, they know that the Trust will never look to get this money back. Clemenza points out that he does not trust anyone, unless they are Family.

Signor Clemenza, the renowned football agent

Sir Sam comes up with the solution, but without asking Mr Waxendale-Balker, or anyone else. He provides Clemenza with a letter for each of the players on Melchester Rovers notepaper, confirming that the loans will never have to be repaid, and that, if they are ever called upon to repay them, Melchester Rovers will refund the Trust. Clemenza is happy, as are his players, and he persuades the “sweetie billionaire” that, with the money he has saved, he could actually afford another of his players, Wilhelm, an experienced Dutch international.

As the years pass, Melchester Rovers remain hugely successful, and fulfil Barlow’s boast that, for every ten pounds spent by their archrivals, Melborough, Melchester will spend twenty.

Sir Sam Barlow, the “sweetie billionaire”

These schemes are so effective and efficient that a number of top quality players sign for Melchester over the years, and everything is rosy.

However, a fateful error occurs. I print below the text of an Internal HMRC Memo detailing what happened.

“HMRC Memo – Mildly Secret – Only to be read by Executive Officers and Maintenance Engineers

From Hector, the Inspector

To Lecter, the Collector

Hi Hannibal!

I wanted to report on my visit to Melchester Rovers. I know that ever since you took over the EBT department in Tax Towers, you have wanted to nail Melchester and Sir Sam Barlow, especially as you want to see Melborough win the league from your seat in the directors’ box. Well, good news!

We were in for a routine inspection, or as you said, “lift every carpet in the place till you find something”. You won’t believe it! In the “Personnel” filing cabinet in their office we noticed a folder labelled “HMRC MUST NOT SEE THIS FOLDER”.

We thought nothing of it until, as we were about to leave, the Director of Finance at Melchester said “You’re all done? Glad you didn’t look at the secret folder!”

I therefore thought this might be worth investigating. Lo and behold, the folder contained 37 separate letters, all on Melchester notepaper and signed by Sir Sam himself. Each letter tells the player to whom it is addressed that “Don’t worry about the wages we are paying you through the Trust as a loan – we confirm that you will never have to pay it back.”

I suspect this might be useful in showing that the EBT has been operating improperly.

Kind regards,

Hector.”

“You do not want me to look at this secret file?” said Hector from HMRC.

From that point the walls of Mel Park come tumbling down. HMRC demand settlement of millions of pounds in unpaid tax and National Insurance, together with interest and penalties. Sir Sam’s letters are the “smoking gun” proving that the Trust “loans” were “disguised remuneration”. It is not known if Melchester Rovers’ Director of Finance “sleeps with the fishes”.

 

Back to Reality

It is alleged that Rangers players and officials too benefited from the relevant EBT by receiving what was truly taxable income through it.

Whilst the Trust in question was set up covering a number of companies in the Murray International Holdings empire, assessments of tax regarding Rangers employees would come to Rangers.

The first determination issued by HMRC asking for payment of tax due as a result of the EBT’s was sent to Rangers in February 2008. After receiving further Determinations, an appeal was lodged and this ground its way through the First Tier Tribunal for many days spread over a couple of years. The case concluded on 18^th January 2012 and a decision is still awaited.

The interests of Rangers were represented by Mr Thornhill QC, the creator of the EBT device along with Mr Baxendale-Walker. As part of the terms of the takeover or Rangers by Mr Whyte, the control of the appeal lay in the hands of Murray International Holdings, not Mr Whyte and Rangers.

As the case progressed, there were various references to “favourable” legal advice.

Often legal advice and the “spin” placed upon it, depends on the question asked.

If Mr Thornhill was asked if Rangers would “win” the appeal, then it all depends on what one means by “win”.

Andrew Thornhill QC – one of the leading Tax Counsel in the UK

For example, on one view, a decision which reduced Rangers’ liability by £1 would be a “win” (though a Pyrrhic one). Some might view a “win” as being Rangers escaping with no liability at all, and any sum at all being payable as being a “defeat”.

Of course Rangers did effectively “win” the case so far. It was able to continue operating, and spending, for almost four years before administration arrived, not as a result of this case at all. All the time this potential bill loomed over the Club, but no provision was made to pay anything of it by Sir David Murray, John McClelland, Martin Bain or anyone else.

The Tribunal was held in private, possibly on security grounds, but it is expected that the judgment will be published, and even though the hearing was private, it is not necessarily the case that the judgment would be anonymised.

The case took so long, it is understood, because each individual payment from the Trust would have had to be looked at. Rangers appeal is against an assessment totalling around £36 million pounds in unpaid tax and interest and a later hearing would normally have been needed, in the absence of agreement, to establish penalties. Penalties can run to 100% of the unpaid tax in particularly heinous examples.

As Rangers are on the way to liquidation, there is unlikely to be any substantive hearing regarding penalties.

 

What Does HMRC Really Think of EBT’s?

The Government published a detailed look at the issues of “Disguised Remuneration” prior to changes in the 2011 Finance Act to clamp down on what the tax authorities see as abuse.

As the document says:-

“In many cases, these third party arrangements allow an employee to enjoy the full benefit of a sum of money paid or assets provided while arguing that, because of the structure of the arrangements, there is no legal right to the money or assets. This argument is used to support a proposition that income tax and national insurance contributions (NICs) are due (if at all) only on the use of the money or assets during the period of the employee’s employment and not on their full value.”

So even “legitimate” use of EBT’s to reduce tax liabilities has ended.

The Government estimates that these measures will increase tax revenues by around £500 million per annum. It was thought that there were around 5,000 employers and 50,000 employees benefiting from these schemes.

As the consultation document stated:-

“The objective of this legislation is to prevent the avoidance or deferral of income tax and NICs on employment income. It will impact on employers and intermediaries who use trusts or loans to reward employees with a view to avoiding or deferring paying tax and NICs. The data which HMRC has on known arrangements suggests that there is a broad range of employers who have implemented these arrangements – around 5,000. The type of businesses thought to be involved ranges from large employers in the financial services industry to single-employee limited companies.”

I think it is fair to say that HMRC do not like EBT’s whether operated “corrcetly” or not!

Posted by Paul “Billy’s Boots” McConville