SE11809 - PAYE avoidance: readily convertible assets

Section 203F(2)(e) ICTA1988

DTE Financial Services Ltd v Wilson

In 1995/96 DTE awarded bonuses to 3 directors. The bonuses were in the form of reversionary interests in an offshore trust (RIOT) and the scheme followed the steps in example SE11825.

The facts of the DTE case, and the High Court decision, were reported in Tax Case Leaflet 3597 but DTE appealed that decision to the Court of Appeal (CA), which delivered judgement on 3 April 2001.

The Revenue contended in the CA that the employer should have operated PAYE because:

• under the principle established in WT Ramsay v CIR (54TC101), if one disregards all the intermediate steps involving the trust, the employer made a cash payment to the employee under Section 203(1) ICTA1988: and/or
• the RIOT was a tradeable asset under Section 203F ICTA1988. The events between establishment of the trust and its inevitable cessation amount to a trading arrangement (see SE12011) to enable the directors to receive an amount similar to the cost incurred by DTE in purchasing the RIOT.

DTE contended that the Ramsay approach could not apply to PAYE but the CA dismissed this argument and identified three relevant stages to the composite RIOT transaction in DTE, following creation of a trust on DTE's instructions on 24 April 1995

• on 25 April, purchase by DTE for £40,600 of a contingent interest in an offshore trust ;
• on 26 April, assignment by DTE of that interest to the director of DTE ; and
• on 28 April, payment of a cash sum of £40,000 by the trustees to the director.

The trust deed stipulated that the trust would inevitably cease on 28 April, the interest in the trust would revert to the beneficiary who would automatically receive the capital held in the trust. Following assignment of the interest by DTE on 26 April, the director was the sole beneficiary and he duly received a payment of £40,000 from the trustees. The difference between the amount paid to the director and the £40,600 paid to purchase the RIOT represented commission to the scheme provider.

The CA upheld the Revenue's contention that, applying the Ramsay approach, the £40,000 was a "payment of assessable income" within Section 203(1) ICTA1988. Consequently DTE should have operated PAYE on this amount.

This conclusion decided the appeal and so it was not necessary for the CA judges to consider the alternative argument but they briefly did so. The CA rejected the Revenue's contention that the RIOT was a "tradeable asset" within Section 203F ICTA1988 because that term relied on the existence of "trading arrangements" to turn the asset (the RIOT) into cash.

The CA decided that the definition of "trading arrangements" in Section 203K(2) required the arrangements to be external to the asset, whereas in DTE the cash payment resulted from the cessation of the trust. This was an integral feature of the asset established in the trust deed and since it was not necessary for any external arrangements to cause the trust to cease, and trigger the cash payment, there were no trading arrangements. Hence the RIOT was not a tradeable asset.

Please note that Section 203F was substantially amended, and Section 203K was almost completely deleted, by Finance Act 1998 ( SE11802).

Action as a result of CA decision in DTE

DTE petitioned the House of Lords for leave to appeal but the petition was refused and the case is therefore final in the CA. Memo SCS51/01 explains how to deal with cases involving payment by RIOT.

RIOT awards after 5 April 1998

From 6 April 1998 the new definition of a readily convertible asset in Section 203F(2)(e) refers to schemes such as RIOTs and there should be no further doubt that employers must operate PAYE on awards of this kind (see SE11808). The evidence available suggests that advisers stopped providing RIOT schemes after 5 April 1998.