Insights

As we have highlighted in a separate blog this month, the use of Employee Benefit Trusts (EBTs) in tax planning ‘schemes’ as has been popular in recent years, is currently under the spotlight from HMRC. However, not all Employee Benefit Trusts are used in this way; many are used as intended, for example in conjunction with employee share option schemes. It is not therefore the case that all such trusts are viewed negatively by HMRC, as demonstrated by the fact that Employee Ownership Trusts (EOTs) were incorporated into Finance Act 2014.

EOTs are intended to be used to facilitate employee ownership in their employing company; the government would like to see significant growth in the number of companies that are owned by their employees as they believe this will help create a range of economic benefits. Numerous research studies have highlighted the benefits to companies of awarding their employees shares, in terms of improved morale, loyalty, work ethic and general motivation levels, because staff can directly share in the financial success of a company.

Employee share ownership through an EOT is quite distinct from other share ownership schemes; the most popular of which for SMEs are currently:

• Employee shareholder status - introduced with effect from September 2013 enabling a minimum of £2,000 worth of shares to be offered to employees free of tax provided the employee has agreed to give up certain statutory employment rights, for example; the right to appeal against unfair dismissal; redundancy payments; the right to request time off to study, or request flexible working.
• Enterprise Management Incentive – intended as a method by which SMEs can offer tax efficient share options to a select number of key employees. Employees are awarded options to purchase shares at a later date for today’s market value and are able to benefit from a number of tax incentives.

What are EOTs?

They are a new method of achieving employee share ownership, enabling shares to be held on behalf of employees within a separate entity; a form of discretionary trust. In order for the preferential tax treatment of an EOT to apply, the trust must operate for the benefit of the majority of employees, rather than targeting a narrow range of employees. A good example of an EOT in action would be John Lewis, which is owned by its partners; the employees, who each receive performance related bonus payments. A significant amount of financial support is being provided by the government to help the EOT policy succeed, with £50m set aside by the Treasury per year to support the growth of employee ownership and to provide two new tax reliefs; it seems that an employee trust will be a key feature of both.

What tax relief does an EOT offer?

The new tax reliefs which will be available through the use of EOTs are:

• Exemption from capital gains tax for individuals who sell a controlling share interest in a company to an ‘indirect employee ownership structure’. This is in contrast to the traditional exit route for a business owner, who will typically claim entrepreneurs’ relief and pay 10% capital gains tax on the first £10m of gains arising on the sale of shares in their trading company. For company owners selling shares to an EOT in qualifying circumstances, tax relief is available and the transaction will be regarded by HMRC as being without either gains or losses;
• Exemption from income tax and NICs on bonuses paid by ‘indirectly employee-owned companies’. A tax free annual bonus of up to £3,600 can be paid to all trust beneficiaries (employees) from 1^st October 2014, provided they have completed at least 12 months’ service.

Establishing an EOT could be a useful strategy for companies looking to offer a form of share ownership to a wide range of employees. It might also be a convenient vehicle for transferring a company’s ownership to employees as part of a succession plan.

The company is able to fund the trust from accumulated profits, with the trust using these funds to acquire shares. Typically, a company will build up funds over several years until it is ready to make a cash contribution to the trustee to finance the purchase of shares from existing shareholders. The shares it acquires can then be distributed to employees and/ or retained within the trust.

If you are considering a company share scheme, or want to explore options for succession planning or a business exit, please contact Lesley Stalker to explore the tax implications by emailing las@rjp.co.uk