Employee Benefit Trusts - Who, What, Where, When and Why?
Due to their origin, trusts are seen as a very English concept, a sentiment shared by the European community. Traditionally they have only existed in the jurisdictions where England exported laws, such as the USA, Australia, Channel Islands, etc. However, as time has progressed, other countries have seen the benefits, and the idea has been widely adopted in places such as Italy and Japan.
What is a Trust?
In the context of an Employee Trust, [also known as an Employee Benefit Trust (EBT), or Employee Share Ownership Plan (ESOP)], a Trust is a discretionary entity that has the ability to borrow for the purpose of investing in the company’s shares.
To gain a wider understanding, it might help to think about the three main characters involved in an EBT:
- The Settlor: this is the person who decides they want to make some shares (or perhaps some cash) available for others. The Settlor is usually the Company, but may occasionally be an individual shareholder.
- The Trustee: this is the person who is ‘entrusted’ to look after the shares or cash for the benefit of others. It is usually a special trustee company, but it is also possible to have one or more individuals acting as the Trustee. This company, individual or group is the legal owner of the Trust shares, and is legally obliged to act in the best interests of the Beneficiary.
- The Beneficiaries: The people, usually the employees, former employees and close relatives, who are supposed to benefit eventually from the shares or cash. While the Trustee has legal ownership of the Trust shares, the Beneficiaries have an equitable interest in it.
Typically an Employee Share Ownership Plan will be funded either by loans or contributions from the company, or by a bank loan that is guaranteed by the company.
What are the rules?
The Settlor will set out what is to happen in a document (called a Trust Deed or a Settlement). For example, it will usually say that the Trustee will look after the cash, shares or other assets during a set period (typically up to 125 years).
The Trust Deed will usually state that the Trustee has discretionary power to decide which of the Beneficiaries will receive an award from the Trust, and the method by which this is to be transferred to them. For example, they might be given the right to free shares or shares at a discount under an option, or the income from the shares might be paid to them as a form of dividends. The Trustee is not permitted to apply the benefits of any shares or cash held in the Trust to anyone other than the Beneficiaries.
A Beneficiary must either be an employee or officer of the company, or the spouse or dependant of an employee/officer. Note that it is not permitted to name the sponsoring company as a Beneficiary to the Trust.
There is deliberate flexibility.
Who governs the Trust?
The Trust will be governed by the relevant law, e.g. English law if the trust is set up in England. There are very high levels of responsibility imposed on a Trustee to act fairly, to act in the best interests of the Beneficiaries and to not make any profit personally out of the Trust (except as permitted by the Trust Deed).
The Beneficiaries will have certain rights both under the Trust Deed and by law.
The Trustee has to complete an annual tax return in the UK and pay tax if relevant.
The Settlor, as the Company, usually has some rights to make recommendations and sometime to veto acts of the Trustee.
What is the point of a Trust?
Some common reasons for establishing an Employee Trust are listed here:
- Succession planning: A retiring shareholder can sell shares into a Trust, which can then be used to transfer awards to the successor employees (the Beneficiaries). This is typically quite a tax efficient means of transferring shares.
- Share liquidity: An EBT provides an internal market for employees to buy and sell shares.
- Employee share plans: To offer shares to employees under an Enterprise Management Incentive (EMI) or other option arrangement.
- Warehousing of employee shares: The Employee Trust can be used as a reserve for employee shares, allowing them to be released over time for the purposes of employee incentives.
- Preventing shareholder dilution: Shareholder dilution can be avoided by using an ESOP to acquire and recycle existing shares, instead of issuing new shares.
An Employee Trust can hold shares in the company that sets it up, whereas a subsidiary usually cannot. That means the Trustees can own shares and use them:
- To buy and sell shares from employees who leave when there is no other market for the shares.
- To co-own shares with employees to help them get the benefit of shares when they cannot afford to pay for them at the moment.
- To pass out dividends for the benefit of employees.
If you would like to know more, additional information is available via our EBT fact sheet.
For further advice please call the RM2 team on 020 8949 5522, or alternatively you can send an e-mail to Kerrie.Willis@rm2.co.uk.