In another landmark decision for HMRC, Leeds Design Innovation Centre has lost a case at the First Tier Tribunal (FTT) over an employment benefit trust (EBT).

The FTT dismissed the taxpayers' appeals finding that loans made under an employee benefit trust were to be taxed as 'cheap loans' or 'beneficial loans' as no interest was paid on the loan agreements for the years in question.

In the case of HMRC v Leeds Design Innovation Centre Ltd [2014] UKFTT 009 (TC), Mr Noble and Mr Connolly are directors of Leeds Design Innovation Centre Ltd and Mr Watkiss is an employee of the company. The company set up an employee benefit trust (EBT) with the trustee of the EBT being a Guernsey resident entity. The EBT lent funds to a British Virgin Islands entity, AE limited (AE), which made loans to Mr Noble and Mr Connolly (the directors) and Mr Watkiss.

The loans were made on the basis of discount agreements. Each individual had to repay their loan on the tenth anniversary of entering into the agreement. The repayment terms included an obligation on the borrower to make a payment of a sum described as a 'discount'. The loans were due to be repaid during 2008 and 2009, but Mr Watkiss did not repay his loan until April 2012 and the directors refinanced their loans under finance agreements with AE in 2010.

HMRC contended that payments were in fact discount because on the drafting of the discount agreements the repayment amount included the full amount of the discount due, even if the loan was repaid early. The discount was not accruing on a daily basis as interest would have. However, even if the payments could be treated as interest, they could not be treated as paid 'for' the relevant years in question.

The FTT agreed with the appellants, on the basis of Lomax v Dixon (25 TC 353), that a payment which contains no element other than a Libor-based return, differentiated from interest only because it is paid at the end of the loan, cannot be anything other than interest. Therefore, the 'discount' payable under the agreements should be treated for tax purposes as interest and not discount.

However, the Tribunal concluded that while there was no argument that Mr Watkiss' payment was made when he paid off the loan, the refinancing by the directors should not, in this case, be treated as amounting to payment of interest.

The Tribunal dismissed the income tax appeals and as the point of issue was the same for the company's appeal against Class 1A National Insurance Contributions (NICs), this appeal was also dismissed.

CCH tax writer Julie Clift said: 'HMRC is increasingly looking at arrangements made under EBTs. In this case concerning employment-related loans, the payment of a 'discount' at the end of the term of the loan could be treated as a payment of interest and would have taken the arrangements outside a charge to tax if the loans had been repaid and an election had been made in time to treat the payments for earlier years.'