Long term incentive plans (LTIPs), Employee ownership trusts (EOTs) and Employee Benefit Trusts (EBTs)

A short overview is helpful to get an understanding of what you may need. In a nutshall the uses are:

• Companies implement a Long Term Incentive Plan (LTIP), for senior executives whose planned awards fall outside of the permitted maximum of an HMRC approved share plan. LTIPs can be operated in conjunction with approved and unapproved option awards and or share awards.
• Employee Share Ownership  Trusts are being increasingly used by the owners of a business to create a sale which is 50% free of capital gains tax and approved by HMRC. We can review the position to consider key red flags which could jeopardise tax relief for the sellers such as price exceeding market value, limited employee benefit and trustee independence. We also draft the documentation needed and secure approval from HMRC.
• Employee Benefit Trusts are used to warehouse shares and provide a market for shares so that employees can realise value. Usually the trust is set up off-shore for CGT savings. The employer funds the EBT and it uses the funds to acquire shares. We draft the documentation and liaise with the trustees who will operate the EBT and deliver shares to employees.

LTIP – The basic idea of an LTIP

The basic idea behind a LTIP is that participants receive share options or shares if they satisfy certain performance criteria over time. Sometimes, the LTIP participants have to invest a proportion of salary or cash bonus towards the acquisition of shares.

With LTIP’s an Employee Benefit Trust is normally set up and the directors select the participants, performance criteria, required share retention period and terms. Tax planning is usually part of the design of the plan and is an area we can advise on.

Performance criteria under an LTIP

The pay out from the LTIP depends on performance targets linked to the company’s growth metrics.  Increasingly performance targets include soft or behavioural components to promote the culture of the company.

How are LTIP's taxed

• Taxation of LTIPs depends on the nature of the award. LTIPs can be taxed as:
• A bonus paid in shares and taxed as income from employment;
• A share option – depending on whether the option is approved (CSOP), or unapproved, capital treatment may be available.

LTIP : holding shares in an Employee Benefit Trust

Most companies which operate LTIPs hold LTIP shares via an Employee Benefit Trust (EBT). An EBT provides an internal market for shares which makes the LTIP very attractive for employees.

Why use of an Employee Ownership Trust (EOT)?

An EOT is an employee benefit trust set up as a vehicle for the owners of a trading company to pass ownership to a trust for the benefit of the employees.  On sale to the EOT 50% of the gain is received by the sellers tax free and the other 50% of the gain is held over until the trustees sell the shares transferred to the EOT.

An EOT structure would typically be used when exiting shareholder(s) wish to reward the existing employees by enabling them to own the business via the EOT.

There are some restrictions to consider. For example, the EOT does have duties which would prevent it from agreeing to pay more than the commercial market value.  The usual way to agree the market value is to consider EBITDA. The EOT can pay less than market value if the sellers agree to this. Businesses can be gifted to EOTs for no consideration which can be attractive to sellers looking to retire and pass the business onto the next generation.

Key points to note with Employee Ownership Trusts

• The EOT must operate for the benefit of ‘all employees’ ‘on the same terms’.
• The company must be a trading company or part of a trading group – HMRC has definitions of what trading means. The intention is to rule out investment companies.
• The EOT must acquire a controlling interest in the trading company (more than 50%).
• The number continuing shareholders who are directors/employees must not exceed 40% of the total number of employees in the company – this means very small companies may not qualify.
• Selling to an EOT allows employees to indirectly buy the company from its shareholders without them having to use their own funds.
• Choosing to sell to an EOT creates an immediate purchaser and is generally seen as a friendlier purchaser. This means the sale will often be quicker and have lower professional fees.
• Shareholders can sell their shares and pay 50% of the capital gains tax bill arising.
• Minority shareholders who do not have a "controlling interest" are not forced to sell their shares.

All employees

Tax free bonuses of up to £3,600.00 can be paid to ‘all employees’ from the EOT. The reason this must apply to all employees is that the trust must benefit all employees on equal terms.

Drawback to EOTs

In practice the biggest drawback will be finding a management team that are capable of running the business once the owners have sold out to the EOT.  However, there is a bridge as the directors will still run the company, the EOT acts only as a shareholder, and therefore does not control the day to day running of the company. This means the board are still able to make decisions.

This point is important if the sale to the EOT is intended to be on a commercial valuation which releases funds via loans to the sellers. A weak management team may not be able to generate the funds to repay any loans made by the business to the sellers.

Employee benefit trusts (EBTs)

An EBT is a discretionary trust established to hold shares or other assets for the benefit of employees, and in some cases their families or dependants. EBTs are widely used to support LTIPs, share option plans, and other incentive arrangements.

Function and tax treatment of EBTs

EBTs work by allowing the employer to make contributions to the trust, which are then held and managed separately. The trustees may use these funds to provide a range of benefits, such as bonuses, incentive awards, or employee share schemes. The trust is discretionary meaning that individual employees do not have an automatic entitlement to trust assets until a benefit is awarded.

There is no general tax break for sellers transferring assets to an EBT. A transfer or sale of shares or other assets to an EBT is normally treated as a market-value disposal, giving rise to CGT. While reliefs may apply in limited circumstances, these depend on the facts and are not specific to EBTs. Advance clearance from HMRC may be sought in appropriate circumstances to obtain certainty.

The trustees are usually resident off shore and are exempt from capital gains tax on the sale or transfer of shares held by the EBT. UK resident trustees are subject to capital gains tax.

Benefits and drawbacks

A sale of shares to an employee benefit trust provides many of the benefits a seller could receive through a third-party sale but there are incremental benefits, less disruption and confidentiality. They can support long-term retention by aligning employee interests with the performance and continuity of the business.