Employee Benefit Trusts evolved - The Employee Ownership Trust
As part of the Chancellor’s 2014 budget, a new form of Employee Benefit Trust was created: the Employee Ownership Trust.
These trusts were created to help facilitate the creation of stable, long term, employee owned companies. To assist with this, the trusts benefit from two key tax reliefs:
- If the trust acquires a majority shareholding in a trading company (or group), all share sales to that trust during that tax year will be free from Capital Gains Tax (CGT).
- If the trust holds a majority shareholding in a trading company (or group), that company can pay bonuses to employees of up to £3,600 per employee, per tax year, free from Income Tax (although national insurance will still be payable).
These new rules present opportunities for organisations that already include Employee Benefit Trusts as part of their structure and for those that are considering a move to an employee owned structure.
But, as with most tax reliefs, there are some strings attached.
What is an Employee Ownership Trust?
A trust is a special legal entity where one or more trustees hold assets on behalf of a defined group of beneficiaries. Trusts have a long history and Employee Benefit Trusts have also been in existence for many years.
The Employee Ownership Trust (EOT) is a special form of Employee Benefit Trust (EBT).
All-employee benefit requirement
An EOT must meet the “All-employee benefit requirement”. To meet this, the trust must not permit:
- any of the trust property to be applied otherwise than for all eligible employees on the same terms;
- the application of the trust property by creating a new trust or transferring property to another trust;
- the making of any loans to beneficiaries; and
- any changes that could allow any of the above.
Eligible employees are all employees in the company/group, with the exception of certain employees who hold 5% of more of the shares in the company. The trustees of the trust can also choose to exclude employees with less than 12 months of service.
The Equality Requirement
An “Equality Requirement” applies if:
- the trustees of the EOT wish to distribute any assets to the beneficiaries; or
- the company wishes to pay a bonus to the employees using the new Income Tax relief (as noted above, this can allow payments of bonuses of up to £3,600 per employee per tax year, free from Income Tax).
The equality requirement means that any such payments must either be paid equally to all eligible employees or paid proportionately according to one or more of the following criteria:
- Hours worked
- Length of service
These criteria are similar to the criteria already used in relation to HMRC approved Share Incentive Plans and will be familiar to anyone who makes use of these plans.
There are some additional requirements to qualify for the reliefs, designed to limit the risk of abuse of the new provisions. These include:
- The company owned by the EOT needs to be a trading company or the holding company in a trading group.
- To qualify for the new CGT relief, if the company after the share sale has one more employees who hold 5% or more of the shares in the company, these employees cannot make up more than 40% of the employees.
- To qualify for the Income Tax relief, the directors of the company (and those connected with them) cannot make up more than 40% of the employees.
Although the EOTs are new, existing EBTs with significant shareholdings in a company will often qualify as an EOT, so long as they comply with the all-employee benefit and equality requirement.
In the event that the CGT relief has been claimed and the EOT ceases to qualify as an EOT (for example, it made a loan to a beneficiary) or ceases to hold a majority of the shares in the company, this be a “disqualifying event”. In such an event, HMRC will seek to recover the CGT saved in the original transaction from the EOT trustees (not the original sellers).
Who would be interested in EOTs?
EOTs will primarily be of interest to organisations who are or are in the process of becoming employee owned.
It is now widely accepted that employee ownership can bring unique benefits to a company and the economy as a whole (see the side box). There are other models of employee ownership, but a trust based model can provide a stable and long lasting structure for an organisation.
It is important to remember that the EOT only needs to hold a majority of the shares in a company to qualify for the reliefs, so it can be combined with other models of employee ownership; employees can still own shares directly in the company.
An EOT will not be for everyone, but they provide an interesting option for organisations interested in long-term stable ownership structures.
The information provided in this article is a summary, is for general guidance only and represents our understanding of current law and practice. Specific advice should always be taken on any individual matter.