Funding an Employee Benefit Trust
Employee Benefit Trusts (EBTs) are frequently used alongside employee share schemes to ring-fence an equity pool for employees without diluting existing shareholders, or to create an internal market for a private company.
Purpose of the EBT
Funding arrangements will vary according to the Company's position and the purpose behind the EBT. For example, if the Company has sufficient funds, existing shareholders can sell shares to the EBT which can then grant options over those shares, avoiding dilution for the existing shareholders.
Alternatively, if funding from the Company is not available, the EBT can grant options over new issue shares. This is achieved by an irrevocable promise to the EBT that if the Company cannot provide funds to the EBT at the time of option exercise, then it will instead allot new shares directly to it (thereby increasing the total number of shares in issue and diluting shareholders equally).
Typical funding arrangements
The trust is not legally set up until it has some money or an asset. However, an initial contribution can be small, as little as £100. This is a capital payment and so will not be corporation tax deductible (another reason for keeping it small). Direct contributions can be corporation tax deductible in limited circumstances where "qualifying benefits" are paid out to employees within 9 months of the end of the accounting period in which the contribution was made. Otherwise, relief is deferred until the accounting period in which the benefits are paid out. A "qualifying benefit", broadly, is money or assets which are chargeable both to income tax and NICs.
The problem with a contribution is that this cannot be repaid to the Company.
Company gifts £100 to the trustees, the trustees buy shares for £100 and offer them to Employee X for that price under an option. In three years' time the shares are worth £500. Employee X exercises the option, and buys the shares from the trustee for £100. There was no CT deduction for the £100 when it was originally gifted because the shares were not distributed within the 9 month period. On exercise of the option there is a Corporation Tax deduction on £400 (the growth). However, the Company cannot get back the £100 that the trust has from selling the shares to Employee X.
It is usual for the Company to fund the EBT directly by way of a direct contribution rather than a loan (which would typically be interest-free, repayable on demand). This is because, where the Company is closely owned the Company has to pay 25% of the loan made to an EBT to HMRC within 9 months from the end of the accounting period, although that is repayable when the loan is repaid by the trustee. This is a cash-flow cost and until earlier this year there were ways to avoid the liability, now stopped by the Finance Act 2013.
A private company may make contributions to an EBT to the extent that any such loans or payments do not breach the directors' general duties to take account of the working capital cash requirements of the business.
In certain circumstances, it is possible to obtain external funding (e.g. via a bank) for an EBT. This would normally be the case for an EBT seeking to buy a significant shareholding in the Company – for example as part of an employee or management and employee buyout. When third party funding is used, the sponsoring company will usually be required to guarantee the EBT's obligation.
 A 'close company' being a technical term but roughly over 50% of the shares in the hands of 5 or fewer shareholders.