HMRC's Consultation On Employee Ownership Trusts And Employee Benefit Trusts

HM Revenue & Customs (HMRC) is consulting on proposals for targeted reform of the EOT and EBT tax regimes (the Consultation). The Consultation closes on 25 September 2023, so it is not too late to have your say in the Consultation. Please see details below about how to respond to this Consultation and the website link to HMRC's Open Consultation that sets out details of HMRC's reasons and proposals in support of legislative reform.

Background to the Consultation:

HMRC has invited the public to share their views and opinions about proposed reform to the EOT and EBT legislation, with the aim of keeping these types of trust focussed on incentivising and retaining key members of staff rather than using these for improper reasons to facilitate tax relief abuse. Within the Consultation publication, HMRC states that the "key principles underpinning these reforms are to ensure that the favourable tax treatment remains available to those who use EBTs and EOTs for the intended policy purposes, whilst preventing tax advantages being obtained through use of these trusts outside of these intended purposes."

HMRC's Open Consultation published on 18 July 2023

EOT - Consultation

An EOT is a specific type of employee trust which holds a controlling interest in the company for the benefit of all employees on the same terms. EOTs are given tax-favoured treatment through tax reliefs introduced in 2014. These include tax reliefs for individuals who dispose of shares in a trading company or parent company of a trading group to the trustees of an EOT. Where the disposal qualifies for relief, the individuals (i.e. the departing owner(s)) will benefit from 100% Capital Gains Tax relief on their share disposal. Additionally, relief from income tax is available on qualifying bonuses of up to £3,600 per employee of the EOT owned company. The policy objective of the tax reliefs is to encourage and incentivise the growth of the employee-owned sector.

HMRC is consulting on some significant changes to the EOT legislation. These include proposed changes to:

1. 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 (most EOT trustees are corporate trustees i.e. companies set up for the sole purpose of being the trustee of the EOT). The Consultation seeks views on whether this reform should go further and possibly require that the EOT trustee board includes those drawn from specific groups, such as employees or independent persons. This is something Birketts would welcome.
2. Require that the trustees of an EOT are UK residents as a single body of persons. At present there is no restriction on the appointment of non-UK resident trustees, even though the departing owner(s), company and employees are all located in the UK. Appointing non-UK resident EOT trustees would mean that there is no UK CGT on the disposal of the company's shares by the trustee, nor on a deemed disposal were a disqualifying event to occur under the EOT legislation. One of HMRC's concerns is that the appointment of non-UK resident EOT trustees could be done as part of an arrangement to reduce future tax.
3. Amend the Corporation Tax legislation to provide that contributions to an EOT by the company in order to pay for the shares acquired from departing owner(s) are not treated as income distributions. This would be a welcome simplification since practitioners are currently forced to seek HMRC clearances on this point for each transaction.

EBT - Consultation

An EBT is a trust which is set up for the benefit of employees or office holders of a company or group of companies (referred to as an EBT).EBTs may be set up for a range of purposes, such as to reward and motivate key executives through share ownership.For companies listed on the London Stock Exchange (main market), they may be used to maximise headroom for the grant of share-based awards, via market purchased shares, including if institutional investors' guidelines operate to restrict awards of new issue shares under flow rates. In more recent years the operation of EBTs has been impacted (in part) by the Disguised Remuneration (DR) legislation that was introduced in 2010. The DR legislation may bring forward the date(s) on which charges to PAYE/NICs might otherwise apply in respect of share or cash awards or recognition payments where such awards, payments etc. are 'earmarked' by a third party (including the trustee of an EBT) for the benefit of employees/beneficiaries.

Notwithstanding the above, EBTs remain a flexible vehicle for employers to structure a variety of incentives. They also benefit from certain Inheritance Tax (IHT) reliefs if they meet certain conditions, including exemption from IHT on transfers to the trustee of the EBT and reliefs from the IHT tenth anniversary and exit charges.

HMRC's concern is that some EBTs are being set up for the primary purpose of benefiting participators (the key shareholders and people connected with them) from the IHT exemption/relief which is not in line with its policy objective - to encourage the use of EBTs in a way to incentivise a wider class of employees.There are three proposed changes:

1. To restrict persons connected with a participator in the company from benefiting from the EBT for its lifetime. On this proposed change, HMRC has seen cases where the trust deed of the EBT allows individuals connected to a participator to benefit from the capital of it after the participator's death.
2. To only allow a settlor of the EBT to benefit from the IHT exemption on transferring shares to an EBT where the settlor has held the shares for at least two years. Currently there is no restriction on how long settlor must have held shares before their transfer into an EBT to gain this exemption.
3. To exclude participators and persons connected to them from benefitting, so that no more than 25% of employees who are able to benefit from income payments under an EBT can be connected to the participator in order for the EBT to benefit from favourable IHT treatment. Currently persons connected to the participator are excluded from benefitting from the capital of the EBT but are still able to benefit from income payments from the trust.

How to respond to HMRC's open consultation

Written responses can be made by post to HMRC (as follows):

Assets and Residence Team
HM Revenue and Customs
100 Parliament Street
London
SW1A 2BQ

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.