Employee benefit trust arrangements

The scheme

A typical employee benefits trust arrangement has the following features.

• An employer entity sets up an Employee Benefits Trust.
   
• The employee may enter into an agreement to direct salary to be paid to the trust.
   
• The entity contributes to the trust for employees or other people nominated by the employees. Often this contribution is financed through a loan or overdraft.
   
• The trust invests these contributions on behalf of the employees or their nominees, often by loaning an amount equal to the contributions back to the employer entity or an associate of the employer entity or purchasing shares in the employer or associated entities.
   
• A selected employee or person may be invited to acquire an interest (for example, by taking up ordinary units) in the trust. This is generally financed by money borrowed from the trust. Where the trust is not a unit trust, selected employees or persons may be nominated as beneficiaries. The selected employees are predominantly directors or shareholders of both the employer and trustee companies. However, arms length employees may also participate in the arrangement.
   
• The holders of ordinary units are generally entitled to distributions of income in proportion to their holding.
   
• Bonus units may be issued to selected employees or selected employees may become participating members. Corpus may be distributed, at the trustee's discretion, among the holders of bonus units in proportion to their holding and then to participating members. There is no consideration provided by employees to become bonus unit holders or participating members.

The flow of funds

The tax mischief

The taxpayer's legal perspective

The arrangements are designed to defer or avoid tax on the employer company's profits but are structured to purportedly provide a large tax deduction to the employer and avoid a fringe benefits tax liability.

Our legal perspective

The Tax Office has a number of concerns relating to employee benefit arrangements including:

• the deduction claimed under section 8-1 of the Income Tax Assessment Act 1997 in respect of the contribution to the trust may be disallowed, and
• Part IVA may apply to cancel the deduction that has, or may be claimed by the employer in respect of each contribution
• the amount contributed on behalf of employees may be assessable to the employee under section 6-5 of the Income Tax Assessment Act 1997, and
• Part IVA may apply to include the income that has been directed by the employee, as assessable income in the same income year the contribution is made to the trust
• where the contribution is made to benefit a specific employee, fringe benefit tax may be payable on the employer's contribution.

Court decisions

Spotlight/Pridecraft Pty Ltd
The Court held that the contributions were deductible under the general deduction provisions, it also held that the general anti-avoidance provisions in Part IVA of the income tax law applied to strike out the deductions otherwise allowable.

Kajewski & Ors
The Court held that the scheme was entered into only to provide the taxpayer's employer with a large tax deduction to claim against an increased business income. The 'contribution' was not a business expense made for the purpose of establishing a genuine employee retention plan. The Court confirmed the Commissioner's powers to amend assessments going as far back as the 1990 income year where an avoidance of tax was the result of fraud or evasion of the taxpayer's tax agent.

Essenbourne
The Court held that an income tax deduction was not allowable for an amount contributed by a company to an employee incentive trust because the payment was simply a distribution of the company's profits to the three principals of the company.

What you can do

If you are a member of an employee benefit trust you should contact the tax office on 1800 177 006 for further advice.

If you are considering establishing an employee benefit trust you may wish to seek a ruling from the Tax Office on the taxation impacts for participants in the arrangement. For further information, contact the tax office on 1800 177 006.