Do you need an employee benefit trust (EBT)?
There has been plenty of publicity about HMRC scrutiny of employee benefit trusts and headline grabbing attention paid to the tax bills some tax payers have been presented with. Can we look at companies and their employees benefit from employee benefit trusts (EBTs) in the modern world? The headline conclusion is EBTs still offer benefits in the right situation.
We look at:
- When an EBT can solve a problem
- Common uses of an EBT
- Contrasts with EOTs
- Funding and operating the EBT
Overview on when an EBT can solve a problem
Employee benefit trusts (EBTs) still have their uses. HMRC has tightened up on many of the tax benefits but there are commercial reasons why you may need an EBT. In private companies where there is no market for the shares such as an exit or trade sale and there are no shareholders who can or want to acquire the shares an EBT can act as a purchaser for the shares – this is known as warehousing. In real life many companies find they do not need to establish an EBT as there is a way of selling the shares usually upon an exit or a company buy back of shares.
The basics of an EBT
The simple idea is that the purpose of an EBT is to incentivise and reward employees by encouraging loyalty and commitment and a desire to see the company perform well. Employees’ interests become more aligned with those of the shareholders.
An employee benefit trust is a type off discretionary trust established by an employer for the benefit of the company’s employees, former employees and some of their relatives and dependants – the beneficiaries.
The EBT holds employee assets, most often shares, share options and awards but also cash payments and phantom awards for the beneficiaries.
EBTs play an important role for companies, whether seeking to achieve employee incentivisation or security for employees in a tax beneficial manner or otherwise.
Common uses of an EBT:
An EBT should be considered for:
- Warehousing or hiding – to create a vehicle to acquire and hold a pool of shares to satisfy share awards under a company’s employee share plans.
- Multinational companies to cost effectively incentivise a large number of eligible employees in many different jurisdictions, as an alternative to granting share options and/ or issuing shares which can involve a consideration of legal and/or tax rules in each of those different jurisdictions.
- Creating an internal market to enable employee shareholders in a private company to sell their shares and receive value
- Buying shares from shareholders who are required to sell their shares under the company’s articles of association or shareholders’ agreement, for example, an employee shareholder who leaves the company
- Enabling the deferral of employee bonuses, whether in cash or shares.
The use of EBTs will be dependent on whether an EBT fits the approach and objectives that the business owners want to establish or preserve.
Contrast with EOTs
An EBT is not subject to the same rules as an employee share ownership trust (EOT). An EOT is a different structure serving a different purpose. The easiest way to explain this is:
- An EBT acts as market or warehouse for shares held by employees and or directors in private companies. The trustees of the EBT are only responsible for the assets placed under their trust via the EBT. The trustees are not responsible for the management of the employer company. There is usually no change of control when shares change hands as the shareholdings placed in the EBT are normally small and less than 51% of the issued share capital.
- An EOT acquires the entire business and acts as new owners of the shares. The EOT takes over management of the business which becomes employee controlled. The vendors are usually the founders of the company and retire upon sale of their shares to the EOT or at the least take a back seat role.
Some nitty gritty on EBTs
There is wide discretion available to companies on how they set up and run their employee benefit trusts. In practice EBTs are bespoke and designed to suit the needs of the business.
Choice of trustees
The EBT can be administered by a professional trustee company who prepares trust accounts and completes tax returns. Individuals can act as trustees but this is rarer. The trustee company can be a specially formed company set up in the UK or offshore. Offshore trustees are very common because they are exempt from capital gains tax. Jersey and Guernsey are the most popular jurisdictions – we do have contacts and can introduce you to trustees.
Example of how the workforce can benefit under an EOT
If a UK company set up an EBT based in Guernsey and issued to the EBT say 100 shares for £1,000 each for the benefit of the workforce. If the shares were sold at £5,000 each as part of a trade sale the EBT would make a tax free gain of £5,000 less £1,000 x 100 = £400,000 which is available for distribution to employees. The workforce will hopefully have been incentivised to help achieve the exit and remain engaged knowing there was a pot of cash ring fenced for them. The payments made to the workforce by the EBT will be subject to income tax and national insurance under PAYE.
Funding the EBT
The EBT will need to be funded to enable it to acquire shares or other property. Funding can be arranged in different ways. Corporation tax relief is available on payments made to the EBT. There are rules on the timing for claiming corporation tax relief which are broadly aligned to the timing for when the beneficiaries will be taxed.
Loans to the EBT
Usually the loan from the company is made interest free. The loan can include terms for when it must be repaid – for example when the EBT sells its shares as part of the exit. The loan could be made by a third party such as a bank.
If the company establishing the EBT is a “close company” (and many private companies are close) there are tax implications to consider when looking at loans. In practice the rules mean that loans from close companies are not made. Transfers of cash or shares are usually made loan free.
Gifts to the EBT
The company can gift money to the EBT which the EBT then uses to acquire shares. If the acquisition of shares is by way of subscription the gift is in effect paid back to the company by way of the subscription price. Gifts can be made by third parties such as a current shareholder.
If a close company allows individuals who hold 5% or more of the share capital to benefit and escape income tax the company may be liable to an immediate inheritance tax charge.
Operating the EBT
The documentation needed to establish the EBT will be a trust deed which we do prepare for companies. The trustees do have to preserve their independence and discretionary powers. But what happens in practice when the company wants the trustee EBT to consider exercising its discretion in a particular way (for example by transferring shares to a particular employee) is the company sends the EBT trustees a “letter of wishes”. The letter of wishes asks the trustees to take the steps recommended. Usually the trustees comply.
There are reporting requirements to HMRC and we guide employers through the process.