The Government has published a consultation on the future of employee-ownership trusts (EOTs) and employee benefit trusts (EBTs).
What is an EOT?
An EOT is a trust set up for the benefit of employees. In essence, if the existing shareholders of a company transfer a majority of their shares to the trustees of the EOT, the business will then be run for the benefit of the employees as a whole going forward. Certain tax advantages follow, including 0% capital gains tax for those selling shareholders and the ability to pay up to £3,600 tax free bonuses to all employees each tax year.
What is the Government proposing?
With more than 1,400 business now having taken up the EOT model, in order to prevent individuals taking advantage of these generous tax reliefs and not properly entering into the spirit of employee ownership, the Government now proposes significant changes to the EOT legislation, including:
- Preventing former owners from retaining control of the EOT, by specifying that more than half of the trustees must not be former owners or persons connected with them – to ensure balance and to show for tax purposes that ‘control’ had genuinely passed from the original owners to the EOT, most EOTs have a mix of former owners, employees and independents on the trustee board. However, up until now, there has been no specific legislative requirements about the composition of the trustees.
- Requiring the EOT trustees to be UK resident as a single body of persons – again, this ensures that in order to enter into the true spirit of employee ownership, the trustees are not a remote professional offshore trust company (set up for tax purposes), but rather a representative UK based body, potentially including employees of the business.
- Clarifying the corporation tax legislation to ensure that contributions to an EOT by the company, in order for the EOT to fund its acquisition of the shares (including associated stamp duty and any ‘commercial’ interest on outstanding monies due to the former owners) are not treated as taxable ‘distributions’ (i.e. taxed, like a dividend) – HMRC has informally taken this view for some time now, but a ‘non-statutory clearance’ had to be made if certainty was wanted on this point. This proposed change should remove any doubt.
- Making the tax-free employee bonus provisions more flexible by removing the requirement to always include directors in these bonus payments to employees – technical requirements of the EOT legislation can mean that, for example, groups of companies who have certain overseas subsidiaries or companies with non-executive directors, may not always be able to pay these tax-free bonuses to employees as intended. Removing the requirement to include directors should help alleviate this, but HMRC have stressed that any relaxation of the ‘equality requirement’ behind these bonuses must not have the unintended consequence of skewing bonuses toward higher paid employees.
What’s our view?
We broadly welcome these changes as a means to smooth the transition for EOTs and bring EOT run businesses closer in line with the spirit of the employee ownership model which was the original intention of the legislation.
Consultation on EBTs
The Government is also consulting on changes to the taxation of EBTs. An EBT is also a trust set up by a company for the benefit of its employees. It is a flexible mechanism for holding shares for future incentivisation or for facilitating a market in the shares of a private company (known as an ‘internal market’). However, unlike EOTs, EBTs do not have any particular tax advantages and for several years have been the subject of scrutiny by HMRC.
Continuing that theme, the current EBT proposals focus on preventing persons who are 5% or more shareholders in the company which set up the EBT (known as ‘participators’) and persons connected with them, from benefiting throughout the lifetime of the EBT. The consultation also looks at amending the existing exemption from Inheritance Tax for an individual transferring shares to an EBT.
These changes represent another mechanism to limit potential abuses of EBTs for tax avoidance purposes.
Our official response and yours
We are planning to provide a formal response to these consultations along with other advisers in the industry. If you would like us to include your thoughts and views within our response please call us on 020 38189420 or email email@example.com with ‘Government Consultation’ as the subject line – please do this by Friday 15th September.
The deadline for responses to the consultation is 25 September 2023.