In July of this year the Government launched a consultation to ‘seek views on proposals for targeted reform to the Employee Ownership Trust (EOTs) and Employee Benefit Trust (EBTs) tax regimes to ensure that the regimes remain focused effectively on the policy objectives of encouraging employee engagement’.
We published a blog on the purpose of the consultation and its aims here.
The consultation closed on Monday 25th September and our response to the questions outlined are summarised below.
Question 1: Do you have any comments on the proposal to prohibit former owners and connected persons from retaining control of an EOT-owned company post-sale by appointing themselves in control of the EOT trustee board?
- We think former owners should have the ability to be appointed as a ‘Seller Trustee’ as they often see this as a way of protecting their (and other sellers) interests whilst there is still consideration outstanding due to them. However, they should not be in a majority on the EOT Trustee Board. This is important to show that control has truly passed to the EOT.
Question 2: Should the government go further and require that the EOT trustee board includes persons drawn from specific groups, such as employees or independent persons? If so, how should these groups be defined?
- We usually recommend that an EOT Trustee Board contains at least one employee and, where feasible or appropriate, one independent person. The employee trustee position is important so that the employees as a whole can see that their interests going forward will be represented. We think the employee trustee position, could reasonably be a requirement. This could for example, be defined as an employee of the group who is not a director/officer of any group company, with a minimum length of service say, one year.
- The independent trustee role can also be important to give balance and an outsider’s perspective to the EOT Trustee Board. This could be a professional (solicitor or accountant) or someone with experience in a similar business sector. However, we do not think the independent trustee position should be a requirement of the legislation, as an appropriate independent person may not always be available and there is also a cost implication of having an independent trustee, which smaller companies in particular may find difficult.
Question 3: Do you have any comments on the proposal to require that the trustees of an EOT are UK resident as a single body of persons?
- Yes, we think this is a very sensible suggestion, especially given that is important to have employee representation on the EOT Trustee Board. In our experience using a professional offshore trustee company does not achieve the spirit of employee-ownership and they will have no familiarity with the business. It is generally only done for tax planning reasons beyond use of the CGT exemption.
Question 4: Do you have any comments on the proposal to confirm in legislation the distributions treatment for contributions made by a company to an EOT to repay the former owners for their shares?
- Again, we support this. We are aware that many firms seek non-statutory Clearance from HMRC to confirm this point, which is time consuming. Having this set out in legislation would make the position much clearer and free of risk.
- We also think it should be possible for there to be a contractual obligation between the company and the EOT to make payments to the EOT (to enable payments of the outstanding consideration to the sellers) without this triggering an income tax charge. This would provide far greater certainty for sellers that they will be paid. Lack of certainty creates significant risk for them and will sometimes dissuade them from selling to an EOT.
Question 5: Do you have any comments on the proposal that HMRC stops giving clearances on the application of section 464A of the Corporation Tax Act 2010 to the establishment of EOTs?
- We have no comments, as generally, we do not see this as an issue.
Question 6: Should the EOT bonus rules be eased so that tax-free bonuses can be awarded to employees without directors necessarily also having to be included, and would this undermine protections which ensure that bonus payments are not abused or weighted towards some employees?
- We think that a mechanism for directors to be able to waive their tax-free bonuses would be sensible and would not undermine the all-employee nature of these bonuses.
- In addition, for groups, we understand that the director/employee ratio can in practice mean that if one subsidiary fails to meet the test, the whole group will be unable to pay tax-free bonuses. An alternative test, allowing this ratio to be met either on an entity-by-entity basis, or on an aggregated basis across the whole group, would provide more flexibility.
Question 7: Do the EOT bonus rules create any other unintended consequences or challenges in administering the tax-free bonus payments?
- We are aware that many clients wish to use some form of job role/level in their criteria as they usually do in their taxable discretionary bonus schemes.
- In addition, where a group has an overseas subsidiary, the legal status of employees under the local jurisdiction may not always be clear from a UK tax perspective.
Question 8: In addition to the reforms proposed at Chapters 4 to 6, do you have any views on ways the Employee Ownership Trust tax regimes could be reformed to better support employee ownership?
- The ‘trading status’ of companies can cause difficulties, in particular, where they hold substantial (generally meaning more than 20% of value) in cash and investments. This level of holdings is not uncommon in this day and age, particularly given the recent economic uncertainties. Clarity should be provided on this test such that these companies are not disbarred from participating in the benefits of employee-ownership.
- The treatment of interest payments on outstanding amounts due to the sellers should be clarified, in particular, whether these can be a deductible expense for the company.
- The £3,600 limit on tax-free bonuses has not changed since it was first introduced in June 2014 and has been significantly eroded by inflation. We also understand that it was intended for a review of this tax relief to take place within five years of the 2014 legislation, but this review does not appear to have taken place. Taking into account inflation, this limit would now be around £4,600. We would recommend that the tax-free bonus limit should be increased to this value, and that it should be written into legislation that the value of the bonus will be subject to regular review.
- The participator test can be problematic where the company has more than one class of shares. This is quite common in smaller companies where several share classes, with similar (or indeed identical rights) are not unusual or where a special class has been created, for example, to operate an EMI scheme. The definition of a participator by reference to 5% of any share class. rather than 5% of the share capital as a whole, can mean that that these companies are unfairly excluded from establishing an EOT and creates an unnecessary trap for what should be eligible companies.
- The strict rules of the controlling interest test can mean that sellers may be unable to put in place sensible precautions over future actions of the company to protect their interests where there is a considerable amount of the consideration left outstanding. Clarity should be provided on what level of sellers’ consents/protections over the future actions of the company would be permissible without breaching the controlling interest test.
Question 9: Do you have comments on the proposal to confirm the government’s position by making it explicit in legislation that the restrictions on connected persons benefiting from EBT must apply for the lifetime of the trust?
- No comments.
Question 10: Do you have any comments on the proposal to only allow the IHT exemption where the shares have been held for two years prior to settlement into an EBT?
- No comments.
Question 11: Do you have any comments on the proposal that no more than 25% of employees who are able to receive income payments should be connected to the participator in order for the EBT to benefit from favourable tax treatment?
- No comments.
Question 12: In addition to the reforms proposed at Chapter 7, do you have any views on ways the tax treatment of EBTs could be enhanced?
- No comments.
We would expect to hear the outcome of the consultation in the next 3-4 months.