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Secured Unfunded Unapproved Benefit Schemes SUURBS
Many employers with high-earning executives who are subject to the Earnings Cap currently use a Funded Unapproved Retirement Benefit Scheme (FURBS) to provide retirement benefits on salary in excess of the Cap. Under the new tax regime coming into force on 6 April 2006 (A-Day), the tax position of FURBS will be changed to make them a less attractive option. Employers may look to provide these benefits under different types of arrangements. One possibility will be to use a Secured Unfunded Unapproved Benefit Scheme (SUURBS).
What is a SUURBS?
A SUURBS is an arrangement designed to provide security for an unfunded pension promise for an executive in a way that does not attract a benefit-in-kind tax charge for the executive.
First, an employer makes a benefit promise to the executive that is not funded for in advance of the payment of the benefit. A provision is built up in the employer's accounts against the accruing benefits and, when the benefits come into payment, they are paid out of the employer's normal trading resources and are tax-deductible for the employer. The executive is taxed on the benefits in payment in a similar way as ordinary tax-approved pensions.
At the same time, assets of the employer are designated as security for the benefits. The assets remain in the legal ownership of the employer. The SUURBS documentation specifies the events that trigger the charge on the assets. Normally, this would include the employer going into liquidation and the employer not paying benefits in line with the promise. In the event that the charge on the assets is triggered, the assets are sold in order to pay the benefits due to the executive.
Otherwise, the employer can continue to use the assets and receives the benefit of any income or capital gains in respect of those assets. Usually the assets will never be called on and are not used to pay the benefits. In this case, benefits continue to be paid from the employer's resources.
Why will SUURBS be more attracive after A-Day?
An UURBS (secured or not) will become more attractive than a new FURBS after A-Day in most circumstances. When the Earnings Cap was introduced in 1989, UURBS were initially thought to be a simple and effective way to compensate new executives at the time for the capping of their tax approved pension benefits. However, problems with company solvency and questionable legal rights to benefits from UURBS for executives leaving employment before retirement have seen their popularity wane with FURBS being the preferred choice. With new FURBS now looking less attractive, UURBS, and in particular SUURBS, are likely to come back into favour.
However, for existing FURBS the best option will often be to continue with it to benefit from the Inheritance Tax protection enjoyed by these trusts, which may compensate for the increased taxation of income.
What is changing for FURBS?
Currently, FURBS benefit from incurring only 22% tax on investment income, except where the income arises from interest when it is 20%. Capital gains are taxed at the rate applicable to trusts, which since April 2004 is 40% (with taper relief). Members pay tax on contributions as a benefit in kind, but the lump sum benefit at retirement is tax free and, if the member died before benefits came into payment, the fund would be paid to his nominated beneficiaries free from inheritance tax.
After A-Day, returns on FURBS investments will effectively be taxed at the executive's marginal tax rate on funds built up both before and after A-Day. However, funds built up before A-Day will still be able to be paid out tax-free. FURBS contributions after A-Day will not be taxed when they are paid, but the lump sum benefit paid out will be taxed in full. The employer will not be able to claim corporation tax relief until the lump sum is paid out.
How will SUURBS be taxed after A-Day?
The executive will not be charged to income tax on the accruing benefit provided the scheme is set up correctly. The employer will not be able to take a tax deduction in relation either to the accruing benefit or to the purchase of assets to secure that accruing benefit. There will be no National Insurance Contributions (NICs) to pay on the accruing benefit.
When the executive retires, the benefit can be paid as a lump sum, which will be taxed as income in the normal way. Similarly, if the executive takes the benefit as a pension, it will be taxed as income.
There is some uncertainty over whether the new rules will allow a full commutation of the benefits without triggering NICs. This may mean that the option to fully commute the benefit for a lump sum might have to be restricted if NICs are not to be payable on the resulting benefit.
The employer can claim a deduction for the benefits paid.
Why might a SUURBS be better than simply providing benefits above the lifeteime allowance through a normal scheme?
Lump sum payments in excess of the lifetime allowance will be subject to a tax charge of 55% (equal to 25% plus income tax on pension payments).
The UURBS or SUURBS option has the advantage over a normal scheme of a lower tax bill for the executive (40% rather than 55%). The other main advantage to the SUURBS option is that the funds in the SUURBS are not pooled with the rest of the employees' funds, giving greater priority in the event of financial difficulties at the company, and the fact that the secured assets are not under the control of the trustees of the normal scheme.
This article was drafted with the help of Ian Gault of Herbert Smith.
Barnett Waddingham LLP, January 2005.