Although Employee Benefit Trusts (EBTs) used in tax planning ‘schemes’ are currently under the spotlight from HMRC, a new breed of EBTs, Employee Ownership Trusts (EOTs), are actively being promoted. This was recently demonstrated by the fact that EOTs were incorporated into Finance Act 2014.
EOTs share similarities with other company share schemes and although they operate quite differently, are intended to be used to facilitate employee ownership in their employing company. They can also offer a tax efficient solution for succession planning in certain circumstances.
The government is strongly backing employee ownership and would like to see significant growth in the number of companies that are owned by their employees, because they believe this will help create a range of economic benefits. Numerous research studies have highlighted the benefits of awarding 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.
As a result, EOTs are being financed by £50 million, which was set aside by the Treasury to support the growth of EOTs and to offset the cost of two new tax reliefs they offer.
More on employee ownership:
- Employee Ownership Pilot makes £150 million available
- Government will act on Nuttall’s employee ownership suggestions
- Firms set to benefit from re-think on buy-back system
Unlike other share ownership schemes, such as Enterprise Management Incentive (EMI) or Employee shareholder status, EOTs operate by enabling shares to be held on behalf of employees within a separate entity; a form of discretionary trust. They offer a number of tax benefits, but in order for the preferential tax treatment of an EOT to apply, it must operate for the benefit of the majority of employees, rather than targeting a narrow range of employees, like an EMI scheme would, for example. 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.
What tax relief does an EOT offer?
The two 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 per cent capital gains tax on the first £10 million 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 1st October 2014, provided they have completed at least 12 months’ service.
How can EOTs be useful for succession planning?
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.
This could be the case if an external buyer cannot be guaranteed and the shareholders wish to sell their shares and thereby crystalise the resulting gains. In this instance, although the final price agreed for transfer of the shares into trust may be lower than could be achieved in a traditional business sale, the absence of CGT payable may compensate for any shortfall.
The transaction itself works by allowing the company 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 trustees to finance the purchase of shares from existing shareholders. The shares the trust 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, it is advisable to discuss your strategies with a tax specialist who can offer advice on share schemes, and help you make the right long term decisions.