Changes to the tax treatment of Employee Ownership Trusts

The government published a consultation on 18 July 2023 seeking the public’s views on its proposals to reform the tax treatment of Employee Ownership Trusts and Employee Benefit Trusts. Parties are invited to express their opinions via email via the government website until the consultation closes on 25 September 2023.

This article will focus predominantly on new tax treatment for Employee Ownership Trusts.

What is an employee trust?

Employee Trusts are broadly split into two categories:

1. Employee Benefit Trusts: An employee trust is a trust that has been created solely for the benefit of the employees of a business. These trusts are frequently referred to as Employee Benefit Trusts (EBTs). Typically, EBTs are used to provide a variety of employee rewards, frequently in the form of shares, money, or other assets.
2. Employee Ownership Trusts: An Employee Ownership Trust (EOT) is a legal structure that allows employees to have a significant ownership stake in the company which employs them. This ownership stake is held collectively on behalf of the employees through the trust, which becomes a shareholder in the company. The concept of an EOT aims to promote employee engagement, share responsibility, and a sense of ownership in the business success.

What is the new government consultation?

In order to maintain the targeted goals of rewarding employees and promoting employee engagement, the government’s consultation is used to obtain opinions on ideas to modify the tax treatment of EBTs and EOTs.

What are the current tax benefits of EOTs?

Subject to the rules, a seller who sells shares to an EOT will not pay any tax on the disposal of those shares to an EOT. The transfer of shares to an EOT is not subject to inheritance tax and . there is also additional relief from income tax on qualifying bonuses of up to £3,600 per year per employee.

What are the reforms?

1. Trustee appointments and residency issues

The consultation recommends that at least 50% of the EOT trustee board be made up of non-owners or unconnected persons. ‘Connected persons’ are defined in section 286(2) of the Taxation of Chargeable Gains Act 1992 as spouses/civil partners and close relatives of the former owners. This structure would stop previous owners from maintaining too much control over the EOT. The government states that any breach of these terms after the sale would disqualify the transaction and subject the trustees (or former owner, if the breach occurred within the first year of disposal) to instant Capital Gains Tax. This isn’t that revolutionary – in practice one would expect the board of an EOT trustee to comprise a seller, an independent trustee and one other – such as an accountant or member of the management team.

Under the current policy, there are no conditions against the creation of non-UK resident EOTs. Non-UK resident EOTs are trusts which appoint solely non-UK resident trustees. Compared to UK-resident EOTs, non-UK resident EOTs do not pay Capital Gains Tax on a subsequent disposal. Therefore, the current policy is open to potential abuse as an EOT could appoint only non-UK trustees in order to avoid paying Capital Gains Tax on any subsequent disposal. To prevent this abuse, the government aims to introduce a condition that some or all of the trustees must be UK residents.

2. Funding issues

The government agrees that a prospective tax charge under the distributions law should not stop the establishment of an EOT, and it wants to eliminate this uncertainty and make the procedure simpler for business owners who want to transition their company to an employee ownership model. The government wants to codify this in law, which would also cover stamp duty and any interest that must be paid at a fair market rate.

3. Income Tax Bonus issues

As mentioned above, employees who are party to a qualifying scheme may receive a tax-free incentive of up to £3,600 per year from employee-owned businesses. However, there are strict rules in s312B of the Income Tax (Earnings and Pensions) Act 2003 that govern the payment of this bonus. This includes the participation requirement, the equality requirement and the office holder requirement.

The restrictions were put in place to prevent directors or the highest paid employees in an EOT from receiving a disproportionate share of any bonus. The government is now proposing to change the qualifying bonus payment regulations so that employees can get tax-free incentives without the obligation to take the directors into account.

How to take part in the consultation?

At Chapter 9 of the consultation, there are a series of questions in which parties are invited to give their opinions. Any responses to the questions must be submitted by post or by email to asres.consult@hmrc.gov.uk. All responses must be submitted by 25 September 2023.

For more discussion on the reforms proposed by the government consultation, please contact a member of our corporate team. We would be very happy to assist you.