Employee Benefit Trusts (EBTs): tax changes for close companies
When some employees can benefit from close companies’ EBTs has changed – here’s what companies, trustees, and shareholders need to know
When some employees can benefit from close companies’ EBTs has changed
Some companies establish EBTs as a flexible way to provide employee benefits such as shares, healthcare, or group life cover. Unlisted companies also establish EBTs to make an internal market in their shares and provide liquidity to employee (and other) shareholders.
HMRC consulted on potential changes to the tax treatment of EBTs in 2023. The proposals included that, for certain Inheritance Tax (IHT) reliefs to be available when assets are settled on an EBT, in some circumstances close company ‘participators’ (i.e. shareholders and certain other persons), and individuals who are ‘connected’ with them for tax purposes, should be unable to receive benefits from the EBT.
That consultation’s outcome was published at the Autumn Budget. Draft legislation published then, and now included in the Finance Bill, provides that in certain circumstances some individuals will not be able to receive any benefits funded by contributions made to EBTs by close companies on or after 30 October 2024 (i.e. Budget Day 2024).
Following this change, it might be necessary to amend the terms of an EBT trust deed to ensure that close companies and their participators continue to be protected from lifetime IHT charges when the company funds its EBT.
This article outlines the relevant issues and what actions close companies and EBT trustees should consider (other restrictions on IHT reliefs associated with EBTs confirmed by the consultation outcome, for example where shares are settled on an EBT by individuals, are not discussed in this article).
Tax issues for close companies with EBTs
EBTs are usually funded by loans (which can be repaid if the EBT comes into funds, for example if it sells shares to employees or on an exit event) or gifts – often cash contributions – from their sponsoring company.
If the sponsoring company is ‘close’ (i.e. if it is controlled by its directors or by five or fewer participators), these loans can give rise to ‘loan to participator’ tax charges for the company, and income tax charges for the trustee if the loan is released or written off.
Additionally, unless certain conditions are met, contributions to an EBT by a close company can give rise to lifetime IHT charges for the company’s participators which, in the first instance, are the company’s liability.
What’s changed?
One of the conditions that must be met for a specific relief from IHT charges to be available to the company/ its participators when the company makes a funding contribution to an EBT is that, under the terms of the trust, ‘5 percent participators’ – and any connected persons – can receive benefits funded by the relevant contribution only as cash payments that are taxable as income. A ‘5 percent participator’ includes any person who, in the ten-year period ending with the date of the contribution held, or at the time of the contribution or at any time afterwards, holds 5 percent or more of the company’s:
- Total issued share capital; or
- Issued share capital represented by any class of shares.
For contributions made by close companies to EBTs prior to 30 October 2024, there was no restriction on when 5 percent participators or connected individuals could receive cash payments funded by those contributions for this IHT relief to be available. This remains the case in relation to contributions made to EBTs prior to Budget Day 2024.
However, for contributions made on or after 30 October 2024, 5 percent participators and connected individuals who are within the class of beneficiaries of the EBT cannot receive any benefit funded by the relevant contribution (i.e. including cash payments taxable on them as income) if, immediately after that contribution is made, they represent more than 25 percent of the officers and employees of the close company.
Which companies are most likely to be affected?
It’s important to note that the new 25 percent limit applies to the number of officers and employees of the close company that makes the contribution, rather than to the total number of officers and employees of its group. This means that the new restriction on when certain individuals can benefit from an EBT is more likely to apply to close companies with a small number of officers and employees (e.g. holding companies that have a board but no other employees).
Family companies where board members are more likely to be connected for tax purposes, and companies with specific employee shares classes where individual board members are more likely to be 5 percent participators than they would were there only a single class of shares in issue, are likely to be most affected.
An immediate practical issue will be where EBTs have undertaken to make contingent cash bonus payments to 5 percent participators and/or connected persons but have yet to be funded in full to meet those liabilities.
What should close companies and EBT trustees consider?
Close companies with EBTs, and trustees of those EBTs, should confirm what specific steps might be required to ensure that the relevant IHT relief remains available. These might include amending the terms of the relevant trust deed and/or updating their tax governance and operational systems and processes.
Close companies and EBT trustees should also ensure they could satisfy their key stakeholders – including HMRC and shareholders who might otherwise be exposed to lifetime IHT charges – that the IHT risks are managed appropriately.
Does the EBT trust deed need to be amended?
Trustees and sponsoring companies should review their EBT trust deeds to confirm whether any changes are required.
If the deed is drafted in such a way that this change to the legislation automatically prevents 5 percent participators and connected persons benefiting from contributions made to the EBT in the relevant circumstances, changes to the trust deed might not be required.
However, if the trust deed is not drafted such that 5 percent participators and connected persons are automatically prevented from benefiting from any relevant contributions to the EBT, the sponsoring company and its shareholders might now be exposed to lifetime IHT charges. In these circumstances, the trustees and sponsoring company should confirm both what changes are necessary to remove that risk, and the procedure for making them prior to any further contributions being made to the EBT.
Tax governance and operational issues
Regardless of whether the trust deed needs to be amended, the trustee should take care to establish, in relation to each contribution from the EBT’s sponsoring company, whether the circumstances are such that 5 percent participators and connected persons can – or cannot – receive cash payments funded by that contribution.
Trustees should also ensure their records demonstrate that these points have been considered and, where relevant, that contributions from which 5 percent participators and connected persons cannot benefit can be identified amongst the trust’s other assets.
Close companies and EBT trustees should also be satisfied they could demonstrate to HMRC, if required, that 5 percent participators and connected persons have not, in fact, benefited from any relevant contributions, and be able to assure the company’s shareholders and other participators that these IHT risks are robustly managed.
As part of their review, trustees and sponsoring companies should also confirm for completeness that, where appropriate, the EBT has been registered with HMRC.
How KPMG can help
Our tax and trust law specialists can help close companies and trustees confirm the specific practical impact that these changes will have on how their EBT operates, amend their trust deed or implement alternative arrangements if required, and design appropriate tax governance processes and procedures for their EBT.
Please contact the authors, or your usual KPMG in the UK contact, if you would like to talk through what these changes mean for you.
