Reforms to the tax treatment of EOTs and EBTs proposed in the paper are intended to focus the rules more effectively on the policy objectives of rewarding employees and encouraging more employee engagement. Another objective is to prevent tax advantages being obtained through the use of these trusts outside their intended purposes.
The consultation document sets out proposed reforms to the employee ownership trust (EOT) rules together with reforms to the inheritance tax (IHT) rules applying more widely to all employment benefit trusts (EBTs).
Details about the issues covered by the consultation are set out below.
Employee ownership trusts
EOTs were introduced by Finance Act 2014 to incentivise owners to transition their companies to indirect employee ownership, with control of the company held by the trustees of a qualifying trust. The trustees of the trust are required to exercise their control of the company for the benefit of the employees.
The EOT regime is tax-advantaged as follows:
- Individuals who dispose of shares in a trading company or the parent company of a trading group to the trustees of an EOT, benefit from 100% capital gains tax (CGT) relief on the disposal.
- There is no IHT charge on the transfer of shares to an EOT; the EOT itself is exempt from the IHT relevant property regime.
- Relief from income tax is available on qualifying bonuses of up to £3,600 per year per employee of the EOT-owned company.
Conditions affecting trustee appointments
At present, there are no controls over who can be appointed as trustees of the EOT. The government recognises the benefit of having the expertise of former owners available to an EOT-owned company. However, where the former owner retains control of the company through majority control of the EOT trustee board, it is questionable whether such an arrangement delivers meaningful change for the employees of the company.
The government therefore proposes that more than half of the trustees of the EOT be persons who are not the former owners or persons connected to them. Any breach of these conditions after disposal would be a disqualifying event and lead to an immediate CGT charge to the trustees (or to the former owner, if within the first year following disposal). Connected persons would be defined using the definition at s286(2), Taxation of Chargeable Gains Act 1992.
The government is also interested in hearing views on whether conditions on EOT trustee appointments should be defined further, for example to require that one or more trustees be appointed or elected from defined groups such as employees of the company.
Trustee tax residency
There are currently no conditions regarding the residency status of EOT trustees. Appointment of 100% non-UK resident trustees would cause the trust to be treated as non-resident. This means that the trustees would not be liable to CGT on any subsequent disposal of the target company shares, nor on a deemed disposal were a disqualifying event to occur. Hence, the trust could be used to avoid UK tax on the disposal of the company to a third party.
The government therefore proposes that the trustees should all be UK resident, or if there is mixture of resident and non-resident trustees, the former owner should be UK resident or domiciled at the date the shares were disposed of to the EOT. Any subsequent breach of this disposal would result in a CGT exit charge.
As EOTs do not typically have funds of their own when first established, the consideration they pay for the shares is usually paid to the departing owners over time, commonly funded through distributions of profits paid to the trustees.
Arguably, such distributions could be treated as taxable in the hands of the shareholders under s1000, Corporation Tax Act 2010 (CTA 2010), although HMRC routinely gives clearance that such payments to the former owners are not taxable. The government wishes to provide certainty. It therefore proposes to confirm in legislation that no taxable distributions arise in this situation (including any associated stamp duty and interest payable at a reasonable commercial rate) provided the trustees paid no more than open market value for the shares.
Clearances under s464A, CTA 2010
When a close company loans or advances money to an EOT that is a participator in the company, a corporation tax charge could arise under s455, CTA 2010 (loans to participators). A charge may also arise under s464A where the company makes a payment to the EOT that is not a loan or advance. It is proposed that HMRC will stop giving clearances as to whether payments constitute tax avoidance arrangements. Provided no tax avoidance purpose is present, s464A will not apply.
Income tax bonus issues
Various requirements need to be met for employee bonuses of up to £3,600 annually to be treated as non-taxable. One of these – the office holder requirement – requires that, within an individual company in the group, the number of directors or office holders and other employees connected with them cannot exceed a ratio of 2/5 when compared to the total number of employees. This can cause difficulties where there are companies within the group with just one employee, who is also a director.
Similarly, having non-executive directors in a group company can cause a problem because they are typically not entitled to receive bonuses. However, they would need to receive the bonus to meet the participation requirement.
The government is considering amending these requirements so that tax-free bonuses can be awarded to employees without directors necessarily also having to be included.
Employee benefit trusts
EBTs benefit from favourable IHT treatment as way of incentivising their use to encourage wider employee share ownership.
- relief from relevant property charges at each ten-year anniversary of the EBT being set up;
- relief from exit charges on capital distributions from the EBT; and
- exemption from IHT on transfer of shares or securities in a company by an individual or a close company.
However, HMRC is concerned that some arrangements are being set up where little or no capital is given to the wider class of employees.
One of the requirements for favourable IHT treatment is that individuals connected to a participator in the company cannot benefit from the trust. The government wants to make it explicit that this should continue to apply after the participator’s death and for the lifetime of the trust.
One of the benefits of EBTs is that there is no IHT on the transfer of shares to the EBT. The government proposes introducing a rule where the settlor needs to have held the shares for two years prior to settlement into an EBT to gain this exemption.
Under the current rules, participators and those connected to them are allowed to benefit from income payments made from the EBT. The government proposes introducing a provision that no more than 25% of employees who benefit from income payments under an EBT can be connected to the participator in order for the EBT to benefit from favourable IHT treatment.
If you have any views on these proposals that you would like ICAEW to consider for inclusion in its response to the consultation, please send them to Richard Jones by Friday 15 September 2023.
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