Employee benefit trusts

Approved Share Incentive Plans must be operated with a specific form of employee trust, drawn up in accordance with the relevant legislation. Other schemes may be operated in conjunction with non-statutory employee trusts. These are normally discretionary trusts in which the shares and other trust assets are held at the discretion of the trustees for a general class of beneficiaries, normally the employees, former employees and their families. Discretionary employee trusts are often used for the creation of internal markets in the shares of private companies, and in succession planning. These uses are discussed further below.

Discretionary trusts do not pay tax on cash or assets settled on them. However UK resident trusts are liable to tax on the income and gains arising from the assets they hold. [78] The standard rate is 32.5 per cent. on dividends and distributions and 40 per cent. on other income and gains.[79] However the first £1,000 of income each year is taxed at 10 per cent., 20 per cent. or 22 per cent. respectively according to whether the income is dividends, interest or other income (all 2006/07 rates). Where the settlor has made two or more settlements on the trustees the £1,000 is divided by the number of settlements provided that the tax free band for any settlement cannot be less than £200.[80]

In a discretionary trust, no specific beneficiaries are identified until the trustees exercise their discretion to make an appointment of benefit. This means that no individual employee can be taxed on transfers of assets into the trust, only when benefits pass out of the trust to individuals. When benefits are paid out, the value is normally subject to income tax but treated as net of tax paid by the trustees. Lower rate taxpayers may therefore be able to claim a refund. Broadly, where the tax paid by the trustees would be insufficient to cover the tax due on the grossed up benefits, the trustees must pay the difference.[81]

In the past, discretionary employee trusts were sometimes used for aggressive tax avoidance, typically for the benefit of directors and shareholders rather than employees. As a consequence employee trusts, especially those established by close companies (see Glossary) are now subject to detailed anti-avoidance rules which can result in substantial and unexpected charges. However most of these rules offer exemptions for trusts that (i) include most or all of the employees as potential beneficiaries and (ii) exclude from benefit the company itself and any persons who are interested, directly or indirectly, in 5 per cent. or more of the share capital and/or assets on liquidation. It is important that the trust deed is properly drafted with these requirements in mind and professional advice is essential.

Employee trusts often acquire shares in their sponsoring company using company funds. The provision of these funds would normally constitute unlawful “financial assistance” by a company for the purchase of its own shares. Fortunately the Companies Act provides specific exemptions for employee trusts.

An internal market for private company shares

Many private companies believe that they cannot offer employee share schemes because there is no market for their shares, and employees are therefore unable to obtain a useful benefit.

In fact, a private company can easily create an internal market in its own shares. This is normally done through an employee trust. For example, where a company operates a share option scheme, it can provide funds to an employee benefit trust to enable it to purchase shares from employees who have acquired them through option exercise and wish to “cash in” their benefit.[82] The shares supplied by these sellers can then be used for the next round of share incentives.

An offer to provide an internal market need not be a binding commitment. It may be prudent for companies to offer this facility “subject to prevailing business conditions”. 

Operation of the market

In addition to offering a re-purchase facility, a private company can provide an opportunity for employees to sell to each other. If employees are obliged to sell on leaving the company, shares are bound to become available from time to time. Where the articles require that shares being sold be offered to all shareholders, employees for whom shares are held in trust (but not option holders) are as entitled as any other shareholder to have the opportunity to buy.

To work well, an internal market should offer employees the opportunity to buy and sell on a regular basis and preferably more than once per year. In the case of an Approved Share Incentive Plan, the trustees will not be liable for capital gains tax on any increase in value between acquisition of the shares and their subsequent appropriation to employees, as long as this period is not more than two years, or five years if the shares are not readily convertible assets (see Glossary). 

Implications of an internal market

There are certain implications of offering an internal market:

Warehousing of employee shares

A company may decide to create a reserve of shares from which it will draw over a period of time for the purposes of employee incentives. Creating a fixed reserve ensures that the number of shares issued to employees cannot exceed a certain agreed proportion of share capital. Once that proportion has been agreed by shareholders, the directors can then go forward to manage the share schemes for perhaps several years without having to seek any further shareholder permissions.

If the shares are to be new shares created by the company, the reserve can be created simply by ensuring that there are sufficient authorised but unissued shares to satisfy the requirements of the scheme. Alternatively, if shares are to be acquired from existing employees the company may decide to create a reserve of actual shares. This may also be helpful in demonstrating to employees that the share benefits are real, not merely promises of the company. 

Prior to December 2003 any shares purchased by a company in itself normally had to be cancelled, on the basis that a company cannot be a member of itself. Subsequently, however, companies listed on the London Stock Exchange, quoted on AIM or listed on a recognised stock exchange within the European Economic Area[83] have been able to acquire shares and hold them as treasury shares. Up to 10 per cent. of a company’s shares can be held in treasury. They are not included in share capital for balance sheet purposes and are not included in calculating earnings per share. The shares must be purchased from distributable profits[84] and shareholders’ approval obtained before the shares are acquired.[85]

Arguably a more flexible alternative is to use an employee benefit trust. The trustees can acquire shares either from existing shareholders, or new shares from the company, and hold these for the purposes of employee schemes. If the company does not wish to provide finance to the trustees it can, with shareholder permission, simply allot the shares to the trustees credited as fully paid[86] or at nominal value. 

If the shares are held by a normal discretionary employee benefit trust, the trustees will be liable to capital gains tax on any gains that crystallise in their hands. However in many cases the trustees will simply acquire the shares and grant option or other rights over them to employees at the same price, so that no gain arises. If on the other hand, the shares are to be held over time and passed to employees at progressively higher values, taxable capital gains could arise in the hands of the trustees.

As noted above, the trustees of an Approved Share Incentive Plan are protected against capital gains tax in certain circumstances.[87] In respect of all trusts, there is an extra-statutory concession (D35) that allows trustees to reclaim capital gains tax on share scheme benefits passed to employees in a form subject to full income tax. It will not apply in respect of participants not subject to the UK tax regime. Moreover some companies consider that even the limited protection provided by the extra-statutory concessions cannot be relied upon since HM Revenue & Customs can withdraw concessions at any time. For this reason the company may consider appointing offshore trustees (see below).

When shares are held under discretionary trusts the trustees are under no obligation to pass on any dividends received. If they do so, this will be in the form of a discretionary appointment of benefit on which UK recipients will pay income tax. By virtue of extra-statutory concession A68 trustees can recover amounts which would otherwise represent double taxation on such distributions. 

In some cases it may not be appropriate for the trustees to collect dividends on shares they are holding for the purposes of employee share schemes. In such a case the trust can be established with a waiver of dividends by the trustees. This should be done in the original deed, not after the trust has been established since a voluntary waiver of dividends by trustees would be a breach of their fiduciary duty to beneficiaries.

Selection of trustees

When an employee trust is established the first trustees are normally appointed by the company. These may include one or more directors of the company. However for trusts other than Approved Share Incentive Plan trusts there are advantages in using independent trustees. For example, if the trust is to purchase shares from existing shareholders for the purposes of the scheme, it would be better if the trustees can be seen to be genuinely independent of the company. This would lessen the force of any argument that the purchase is being made by the trust for the benefit of shareholders, rather than employees, and should therefore be subject to income tax.[88]

Independent trustees could include a solicitor or other trusted adviser. Generally, firms of accountants or employees of such firms will be unwilling to act as trustees if they also act as auditors, because of potential conflict of interest. Some share scheme practitioners have trustee companies which can act as corporate trustees. If independent trustees are being used, then it is preferable to safeguard that independence by arranging for the power of appointment of new trustees to reside with the trustees themselves rather than with the company.

There may be advantages in appointing one or more employee trustees. Unless they are also significant shareholders or directors, HM Revenue & Customs is likely to regard them as independent. They can also be helpful in demonstrating that the employee trust is being run in a transparent way for the benefit of employees.

Companies often set up special subsidiaries to act as corporate trustee.[89] The “trustees” are now in effect the directors of the trustee company. Because of the relationship of the subsidiary to the parent, the advantages of independence will be wholly or partly lost. However a corporate trustee has two major advantages:

In some cases the use of a single corporate trustee could cause a company to become close (see Glossary) with potentially adverse tax consequences. 

From time to time trustees will resign and will have to be replaced. If the trust holds assets, then a simple resignation by the outgoing trustee will not be sufficient. The assets jointly held by the former trustees must be transferred to joint ownership of the new trustees by means of a deed of transfer. In the case of shares, this will normally be a simple stock transfer form. There will normally be no tax or stamp duty implications in relation to a transfer of this kind.

Powers and responsibilities of trustees

The trustees of Approved Share Incentive Plans have only narrow powers consistent with their role in operating the scheme. For example, they must take instructions from beneficiaries if there is a rights issue or take-over and they must pass any dividends directly to employees.

By contract the trustees of discretionary trusts normally have wide powers to invest, borrow, appoint agents and generally take any action they see fit. They must however act at all times in the interests of the beneficiaries, even where this might conflict with the interests of the sponsoring company or individual shareholders. In practice the responsibilities of the trustees of a discretionary employee trust are usually straightforward, being to:

The actual design and administration of employee share schemes will normally be handled on behalf of the trustees by the sponsoring company or professional advisers.

Most deeds indemnify the trustees against the consequences of actions taken by them in good faith (but not fraud or willful default). Notwithstanding such indemnities, the Trustee Act 2000 imposes a default duty of care commensurate with the knowledge and experience of the trustees. Part of this duty of care is to take external advice on any investments held by the trust, where this is reasonably necessary. In most cases, the investments of a discretionary employee trust will be cash or shares held for the purposes of an employee share scheme and external advice will not be required.

Offshore trustees

For reasons summarised earlier in this chapter it may be appropriate to place the employee trust in an offshore location.[91] This approach is followed by many companies, including large listed companies. Although the term “offshore trust” is sometimes associated with aggressive tax planning or tax evasion, the use offshore trusts in connection with employee share schemes is generally regarded as mainstream. Where an offshore trust is created this must be reported to the UK tax authorities within three months of formation.

To qualify as an offshore trust the trust must be non UK resident, as (in most cases) must all the trustees.[92] It is also important that the actual direction and administration of the trust should occur outside the UK and that the trustees are not merely the servant of the sponsoring company. This requires that the trust document be correctly drafted to ensure that the trustees have full powers of discretion. All decisions of the trustees, and the reasons for them, should be carefully minuted.

It is open to the sponsoring company to inform the trustees of their wishes in respect to the operation of the trust (usually done by means of a “letter of wishes”) but the offshore trustees are not bound to abide by such wishes and, on occasion, they may decide on a different course of action. They will, of course, be bound by the terms of the trust only to act in the interests of the beneficiaries as defined by the trust deed.

Trustees will not normally provide technical advice but it is helpful if they have detailed knowledge of the issues involved. They should be able to demonstrate a high level of professional indemnity insurance cover in relation to the proposed size of the trust assets. Many firms of trustees are part of larger financial groups including multinational banks. Costs will vary with the expertise and brand-name involved but typically the fee for establishing a simple discretionary offshore trust in the Channel Islands will be around £3,000 to £5,000. Costs will be higher if the trustees are asked to originate the trust deed. Many employee trusts, although held and operated offshore, are drafted subject to English law and this can be helpful in clarifying any issues of interpretation and dealing with enquiries from HM Revenue & Customs.

A typical small employee trust will cost several thousand pounds a year to run assuming little or no trust activity. The costs may be considerably greater if the trustees have to undertake significant administration.

The Channel Islands are a popular choice for trust location since they have a strong regulatory framework, a legal system very similar to that of the UK and are relatively easy to reach. Firms of trustees in various Caribbean locations such as the British Virgin Islands or the Turks and Caicos may be somewhat cheaper but offer few advantages. Switzerland has a well-established reputation in the field of custodian and trust services but the charges can be high and the procedures formal and inflexible.

Share purchases and succession planning

The shares to be used for an employee share scheme can be either new shares, created by the company, or shares acquired from existing shareholders. In either case the existing shareholders will be diluted, but in the latter case they can receive cash. The attractiveness of receiving cash will depend on whether the company has cash available for this purpose (currently or prospectively), and the rate of tax to be paid by the selling shareholder(s). 

In quoted companies, shares can be purchased from existing shareholders on the open market. However the shares may need to be acquired “off-market”, that is, on private terms. This could apply if the purchase is to be from a specific shareholder or the number of shares to be acquired is too large for the market to supply without distorting the share price.

In order to finance the purchase of shares by the trust, the company will usually make contributions to the trust fund. An alternative method is to lend to the trustees, or to guarantee lending to them by a bank or other third party. However if the company is a close company (see Glossary) the provision of loan funds to the trustees will be caught by an anti-avoidance rule that penalises loans to “participators”, i.e. those who are actually or prospectively interested, directly or indirectly, in the shares or profits of the company.[93] This rule is designed to discourage companies from making indefinite loans to shareholders rather than paying taxable dividends. It is likely that the rule was never intended to catch employee trusts, but if a company makes such a loan it is required to make a payment of “quasi-ACT” to HM Revenue & Customs equal to 25 per cent. of the loan. This is repayable as and when the loan is repaid. In practice therefore, if loan monies are to be raised to finance a close company’s employee trust, it is better if the finance is raised by the company and then paid over to the trustees.

Share purchase by company

When company shares become available for sale, the company itself may be a potential buyer. However if the company is not listed then, unless exemptions apply, the gains to shareholders will be taxed as a distribution (i.e. as a dividend), not as capital gains. This is an anti-avoidance rule to prevent companies continuously creating share capital and then repurchasing it in order to make capital payments to shareholders from cash resources that would otherwise be taxed as dividends. 

If the gains are taxed as distributions the effective tax rate on the cash dividends is 25 per cent. for a higher rate tax payer. This is significantly less favourable than effective rate of capital gains tax that would apply, assuming full business asset taper relief.[94] 

A sale of unlisted shares back to the company must meet a number of requirements if the transaction is to be treated as capital in nature. In summary these are as follows:

Taxpayers can apply to HM Revenue & Customs for prior clearance that a proposed sale will be treated as a capital transaction and not a distribution.

Purchases by listed companies of their own shares are not normally treated as distributions. This is because the purchases are usually made indirectly, through a market maker, and sales to market makers do not count as distributions.

Purchase by employee trust

If the sale is made not to the company but to an intermediary such as a bona fide employee benefit trust on arm’s length terms then the transaction is outside the scope of the “deemed distribution” provisions. Accordingly the sale should be subject to capital gains tax not income tax. The use of the shares for the purposes of an employee share scheme also provides a prima facie commercial purpose. Some practitioners have speculated that HM Revenue & Customs could seek to challenge the capital treatment on the basis of general anti-avoidance provisions (section 703, ICT 1988). We are unaware of any cases where this has occurred in relation to a bona fide employee share scheme. 

To minimise the risk of any challenge, we recommend that:

If possible, the terms of the transaction should be such that, if the shares had been purchased directly by the company, the purchase would have qualified for capital gains tax treatment.

Sales into an Approved Share Incentive Plan trust would appear to be immune from any risk of attack. In fact, if at least 10 per cent. of the company’s issued share capital passes into such a trust within a 12 month period and the proceeds are re-invested in another asset chargeable to capital gains tax[95], the selling shareholder(s) may be eligible to receive 100 per cent. capital gains tax rollover relief in respect of the proceeds. This means that no tax at all will crystallise when the shares are sold.

Deferred shareholder sale

As mentioned on page 93 the value that an existing shareholder can obtain through the sale of shares into an employee share scheme may be disappointing in comparison to what that shareholding might fetch if the business were sold or floated. One way to achieve a higher value may be to defer selling the shares to the employee trust until the shares are needed by the trustees to satisfy their obligations – for example on the exercise of options. This is likely to occur when the shares have risen substantially in value, for example if the company is being sold or floated.

This approach requires the trustees of the share scheme to enter into obligations – such as the grant of share options – before they have acquired the necessary shares. The trustees will require certainty that they can obtain the shares they need to satisfy their obligations. A promise from one or more individual shareholders to sell to the trust in the future may not provide the required level of certainty. The only entity that can offer a guaranteed availability of shares is the company itself. The trustees and the company may therefore enter into an arrangement whereby the company, subject to suitable shareholder permissions, offers irrevocable rights to the trustees to acquire the shares when they are needed to satisfy scheme obligations, at a price equal to the ruling fair market value at the date of acquisition. When the time comes to exercise this right, the trustees will still be able to purchase the shares they need from existing shareholders rather than the company and in practice will normally do so if the shares are offered by existing shareholders at a price fractionally lower than fair market value.

Succession planning

The previous section has obvious relevance to situations where, in a private company, one or more of the shareholders wish to retire. The other shareholders may not be able or willing to purchase the shares. They may also be reluctant to invite an outsider to buy them, even if such a buyer could be found.

An employee trust could be used to make an offer for the shares. The trustees would also have the power to borrow to finance the purchase, and the borrowing could be guaranteed by the company, as long as no directors of the company were trustees[96] and the borrowing was for the purposes of a genuine employee share scheme. The shares could then be held and used to provide employee incentives.

As noted above, the selling shareholder may be able to enjoy business asset taper relief on the proceeds. Those who are to receive the shares will pay no tax on their value until they are distributed, perhaps on flotation or sale of the entire company, at which point shares can be sold to raise the funds necessary to pay the resulting tax charge. Alternatively, it may be possible to distribute some or all of the shares to employees in a tax efficient manner via a statutory employee scheme or deferred share purchase plan.

Such arrangements are convenient and tax-efficient for the company, shareholders and employees. No outside investors have been involved.

Occasionally, founding shareholders may want to pass control of a company, or even its entire share capital, to the employees. This may involve a gift of shares into the employee trust. The gift will be a disposal for capital gains tax purposes but hold-over relief will be available if (i) the transferor is an individual (or the trustees of another settlement); (ii) the shares are unlisted or the transferor holds at least 5 per cent. of the voting rights; (iii) the company is a trading company[97] and (iv) the trustees are UK resident.[98] Hold over relief results in the trustees being deemed to acquire the shares at the same cost as they were acquired by the transferor, so that the trustees become liable to any tax on the total gains since their original acquisition.

Gifts to discretionary trusts are normally subject to inheritance tax but gifts of company shares receive 100 per cent. relief providing that they are unlisted shares in a trading company. The transferor must have held the shares for at least two years before the transfer. Relief at 50 per cent. is available on listed shares if the transferor had a controlling stake before the gift. The gift is exempt altogether if within a year of the gift the trustees acquire control of the company.

Employee trusts can also used in connection with management buy-outs. It may be appropriate to reserve a proportion of share capital in trust for the provision of equity linked incentives going forward. Employees can be invited to contribute to the pay down of debt in the new company by subscribing for shares, or by participating in an Approved SAYE Option Scheme or a Partnership Share Agreement under an Approved Share Incentive Plan.

Treatment of non-share benefits

In the past, companies could often obtain corporation tax relief on contributions made to employee benefit trusts, reflecting the basic tax law principle that the expenditure was “wholly and exclusively” for the purposes of the trade. This was increasingly resisted by HM Revenue & Customs from the late 1990s and the Finance Act 2003 finally made it clear that any corporation tax relief due would not be available until a benefit had passed to beneficiaries on which income tax (and NICs) is chargeable (or would be chargeable if it were not for the reliefs available in relation to statutory share schemes). 

The availability of this relief for benefits other than employee share schemes is in fact still not certain – although the relief is now delayed, its availability still depends on rather uncertain case law. In relation to both statutory and non-statutory employee share schemes, however, the legislation provides specific relief. This is summarised on page 30.

Other tax issues

The anti-avoidance legislation surrounding employee trusts contains pitfalls for the unwary. Aspects not so far covered include the following:

Potential inheritance tax charge on participators

If the sponsoring company is a close company, and the trust deed has been drafted so that certain participators[99] in the company are not excluded from benefit, then contributions to the trust by the company will fall to be treated as personal contributions by the shareholders and these contributions will not be potentially exempt transfers for inheritance tax purposes. At best, this will diminish the amount of life-time inheritance tax exemption remaining to the shareholders. At worst, it could lead to an immediate charge to inheritance tax at one half of the death rate (i.e. 20 per cent.)[100]

If this treatment is not to apply, then the participators who must be excluded from benefit by the trust must include those who (i) at the time of the company contribution, or (ii) after the contribution, or (iii) at any time within 10 years prior to the contribution; have or had an interest of 5 per cent. of more in the capital of the company or in its assets on liquidation. 

This treatment does not apply if the potential benefits to participators are limited to payments which are income for the purposes of UK tax (or would be if the participator was subject to UK tax) or if the trust is an approved Share Incentive Plan.

Similar rules apply where existing shareholders gift shares into a discretionary employee benefit trust. Such a gift might be made altruistically, to create an employee-controlled company; even so, the gift will not be a potentially exempt transfer if any 5 per cent. participators can receive capital benefits.

Settlor retains interest

If a shareholder gifts shares into a discretionary trust in which he retains a potential interest, whether or not at the trustees’ discretion, he will be subject to tax on all the income and gain of the trust (“settlor liability”). He can however reclaim this tax from the trustees.

Under the pre-owned assets regulations, a shareholder who gifts shares into a trust in which he retains an interest may also be subject to an amount of tax related to the value of the assets transferred. This is computed as the value of the shares times the official interest rate (5 per cent. in early 2006). There is a de minimis deemed benefit of £5,000 per year below which not tax is paid but above which tax is payable on the whole amount. 

The tax is reduced by any amounts paid out under the settlor liability provisions mentioned above. The effect therefore is that if the deemed benefit from the settled is worth at least £5,000 per year the settlor may pay more, but cannot pay less, than the tax on 5 per cent. of the value of the settled shares annually. The settlor must submit an updated share valuation annually. 

Taking the above provisions together, it seems that it is possible for a settlor to be assessed to inheritance tax on a transfer of shares to a discretionary trust, then assessed to income tax at a minimum rate of 5 per cent. on the entire value every year thereafter.

Possible association of beneficiary with trustees

Generally, beneficiaries of employee benefit trusts are not regarded as “associated” with the trusts for the purposes of the various material interest tests that apply to the statutory schemes. Where an individual has received a benefit from the trust, however, there are complex rules which could result in him being partly associated with the trust shareholding. This could in turn affect eligibility to participate in one or more statutory schemes.

Time-based charges on discretionary trusts

There are detailed rules to discourage discretionary trusts from holding assets over long periods. These include a special periodic charge at the 10th anniversary of the creation of a trust and an exit charge when property leaves the trust.

In respect of the 10 year charge, the assets of employee benefit trusts are “excluded property” and are exempt from the charge. They are not however completely exempt from the exit charge. This arises when the value of property held by a trust is reduced as a result of value being transferred to a beneficiary, and the benefit does not qualify as a “payment” subject to income tax in the hands of a recipient. It is possible that the grant of a nil cost option could be a transfer of value which is not a “payment”, even if the benefit is subject to income tax. Fortunately, the charge is just 0.25 per cent. per quarter (1 per cent. per year) for the first 10 years, it then declines by stages to reach a maximum of 30 per cent. after 50 years. This charge will not be of concern to most employee trusts where benefits are awarded within a short time of the relevant shares being acquired. If a significant charge seems likely to arise, this may be an additional reason to consider an offshore trust.

If offshore trustees crystallise a capital gain, but the gain is not remitted to UK beneficiaries until a later date, a supplementary charge is payable in respect of the period prior to remittance equal to 10 per cent. per annum of the UK tax that would have been payable had the gain been immediately remitted, subject to a maximum of 60 per cent. The charge runs from 1st December in the tax year following that in which the trustees’ gains arose to 30th November in the tax year after that in which the gain is distributed to the beneficiary. The maximum additional tax payable is therefore 60 per cent. of 40 per cent. equal to 24 per cent.

Relief for tax paid by trustees

If the trustees of a discretionary trust make a payment to a beneficiary which, if received directly, would be eligible for relief under a double taxation agreement, or because the beneficiary is not a UK resident and not chargeable to UK tax, the beneficiary may be able to obtain an equivalent relief under Extra-Statutory Concession B18. However, this relief must be applied for or it will be lost.

In order to receive the relief, the payment must arise from payments made to the trustees within the previous six tax years. The trustees must have made full returns of trust income to HM Revenue & Customs and paid all taxes due. Relief may be available to a beneficiary of an offshore trust if he would have been entitled to such relief but only in respect of UK taxes paid by the trustees.

Termination of trusts

It may be desirable to terminate a trust when an employee share scheme comes to an end or the sponsoring company is sold or liquidated.

A non-statutory trust is normally prohibited by its deed from paying benefits back to the sponsoring company, since the purpose of the trust is to provide benefits to employees. On termination of the trust, therefore, the trustees should first consider how they can distribute any remaining assets of the trust to the beneficiaries, who will normally include both present and former employees and their families. However, if there are no remaining beneficiaries, the trustees will normally have the power to appoint default beneficiaries, usually charities selected at the discretion of the trustees. If the trust deed is properly drafted and the trustees act reasonably, they are likely to be immune from attack by potential beneficiaries because the liability of the trustees will be limited to acts of wilful fraud or negligence.[101] 

If an Approved Share Incentive Plan is to be terminated the trustees should normally continue to hold the relevant securities in trust for the remainder of the full five-year term. The trustees may not remove shares from the plan without the consent of participants, and early closure may result in a claw-back of tax reliefs for both employer and employees. 

At termination, the company issues a formal termination notice to HM Revenue & Customs, the participants and the trustees. Any shares held on behalf of participants, and any Partnership Share money held by the trustees, is returned to participants. The trust deed normally provides that any shares or other assets still held by the trustees can then be returned to the sponsoring company.

[78] Offshore trustees may be exempt - see page 72.

[79] Gains of up to £4,250 (2005/06 rates) are exempt from CGT in the hands of the trustees of a discretionary trust (half the personal rate).

[80] This includes any settlements made during the tax year in question. If there is more than one settlor the £1,000 is divided by the largest number of settlements made by any one settlor.

[81] Non-payable dividend tax credits are excluded in calculating the tax paid by the trustees.

[82] Where shares in an unquoted company are to be acquired by an employee trust and the articles of association contain pre-emption rights (see Glossary) it may be necessary for the shareholders to agree amendments to the articles of association.

[83] The countries of the European Union plus Norway, Iceland and Liechtenstein.

[84] See also the implications for the ABI guidelines, page 6.

[85] If the purchase is from the open market, an ordinary resolution is required stating the maximum number and the highest and lowest price that can be paid. The company must acquire the shares within 18 months. If the shares are to be acquired privately (“off-market”) a special resolution is required to authorise the transaction.

[86] Providing the company has sufficient distributable reserves or some other legitimate means of paying up the shares.

[87] The length of time that trustees of a Share Incentive Plan may hold shares without being exposed to a potential liability to capital gains tax is extended to 10 years if the trustees hold 10 per cent. or more of the share capital of the company and have acquired this from one or more individual (non-corporate) shareholders over a period of not more than 12 months commencing on the date of the first acquisition.

[88] When a company repurchases its own shares the payment is treated as a distribution unless certain requirements are met. As far as we know, HM Revenue & Customs has not yet sought to extend this treatment to the purchase of shares by bona fide employee trusts for the purposes of employee share schemes but some practitioners argue that they might.

[89] The Companies Act 1985 prohibits a company from becoming a shareholder in itself but section 23(2) allows a subsidiary to hold shares in its parent company for the purposes of an employee share scheme.

[90] However if the company is close (see Glossary) lending to the trustees of an employee trust will incur a charge to quasi-ACT.

[91] The trustees of a Share Incentive Plan must be UK resident.

[92] If some of the trustees are UK resident and ordinarily resident and some are not, then (from 6th April 2007) if any settlor is UK resident, ordinarily resident or domiciled, all the trustees are treated as resident. Otherwise the trustees are treated as neither resident nor ordinarily resident.

[93] In this case the term “participator” is not subject to a 5 per cent. de minimis exemption.

[94] Even if a disposal is treated as a distribution, the holder still makes a disposal for capital gains tax purposes. However the amount on which income tax is paid is set against the capital gain and therefore no taxable gain arises (in some cases a loss is generated).

[95] There are some exceptions e.g. shares acquired through an Enterprise Investment Scheme.

[96] Companies cannot lend to their own directors (subject to minor exceptions).

[97] Companies mainly engaged in property, investment or dealing in securities are excluded. 

[98] Relief is available for quoted shares if the transferor owns at least 5 per cent. of the issued equity or the transferor is a trust holding at least 25 per cent. of the equity.

[99] A participator is a person who is interested in the income or capital of the company (see Glossary). 

[100] It appears that an employee trust that excludes 5 per cent. participators from benefit could validly create a 5 per cent. participator by distributing shares or granting options to a beneficiary, but such a participator could not then receive further benefits.

[101] Non-statutory employee trusts are normally discretionary and accordingly no beneficiary can sue directly for loss of benefit since they would normally be unable to show any specific entitlement. The Attorney General has the ability, in theory, to pursue a claim on behalf of potential beneficiaries but we are not aware of any case where this has occurred.