Are changes ahead for employee trusts?

HMRC propose changes to the tax treatment of employee trusts – here are the key points

Are changes ahead for employee trusts?

HMRC are consulting on potential changes to the tax regimes for Employee Ownership Trusts (EOTs) and other Employee Benefit Trusts (EBTs). This is relevant to companies and shareholders who are considering indirect employee ownership through an EOT, and to all employers who provide other employee benefits such as healthcare, shares, or group life cover through an EBT. This article summarises key aspects of the consultation and what organisations and individuals who use – or might establish – an EOT or EBT could consider.

What are the proposals for EOTs?

An EOT is a specific type of EBT that offers generous tax-advantages to encourage indirect employee ownership (i.e. where a trustee holds a controlling interest in a company for the benefit of the employees as a whole). 

Provided certain statutory conditions are met, any gain that arises for the vendors when an EOT acquires a controlling interest in a company is free of Capital Gains Tax (CGT). 

The vendors should also benefit from an Inheritance Tax (IHT) exemption for the transfer of shares to an EOT.

Additionally, companies that are controlled by an EOT can pay each employee bonuses of up to £3,600 each year income tax free (though NIC still applies), if certain qualifying conditions are met.

The consultation proposes the following measures to improve the EOT regime and ensure its tax advantages are appropriately targeted:

  • Introducing a specific income tax exemption for certain funding received by EOT trustees (in certain circumstances there can currently be doubt on whether cash contributions that EOT controlled companies make to EOTs should be taxed on the trustees as distributions);
  • Changes to the qualifying conditions for paying income tax free bonuses to ease administration;
  • Ensuring EOT controlled companies’ independence from their former owners by requiring that former shareholders and persons connected with them form a minority of the EOT’s trustees, and do not control any company that acts as the sole trustee (a subsequent breach of this requirement would, depending on the circumstances, lead to a CGT charge on the former owners or on the trustees); and
  • Requiring that EOTs be UK resident for tax purposes (a subsequent breach of this requirement would trigger a CGT charge on the trustees).

What are the proposals for other EBTs?

EBTs that are not EOTs can be established to provide employees with various benefits, such as shares (e.g. by granting share options and/or satisfying their exercise), group life cover, or healthcare benefits. EBTs are often used where it is necessary or more straightforward for a party other than the employer to acquire and hold the relevant assets for legal, regulatory or governance reasons (e.g. with some share plans).

Provided the transfer meets certain conditions, individuals who gift assets to EBTs can benefit from IHT relief.

EBT trustees can also benefit from specific income tax, CGT, and IHT reliefs or treatment that can maximise the value of the assets available to incentivise and reward employees as part of their total employment package or reduce the incidence of double or additional taxation.

However, in some cases, these reliefs are narrowly drafted and might not prevent unexpected tax charges arising. Such unexpected charges are often only identified during due diligence exercises and might need to be funded by the EBT’s sponsoring company.

To ensure that the tax treatment of EBTs remains appropriate, the consultation:

  • Proposes legislative amendments to clarify that for certain IHT reliefs to be available, individuals who are ‘connected’ with close company participators who settle assets on an EBT, cannot receive certain benefits from the EBT at any time; and
  • Invites suggestions on how the tax treatment of EBTs could, in general, be improved.

What should stakeholders consider?

Shareholders who are considering an exit that might involve an EOT, or who are otherwise considering moving their company to indirect employee ownership, should consider what impact the proposed reforms might have on their planning (we presume that any changes to the EOT regime would affect only arrangements put in place after those changes become effective, but this is currently uncertain).

For employers who operate other EBTs, this consultation presents an opportunity to highlight tax issues that currently create barriers to effectively incentivising and rewarding employees – and suggest improvements to the regime. Employers who operate EBTs in connection with employee share plans might wish to consider this in conjunction with HMRC’s consultation on how tax-advantaged ‘all employee’ share plans might be improved or simplified.

For example, some employers who operate EBTs in conjunction with employee share plans find that unexpected tax charges arise when:

  • They fund EBTs to acquire shares (e.g. where unlisted ‘close’ companies fund an EBT to make a market in their shares for the benefit of employees, loan to participator charges can arise for the company);
  • An EBT grants options to employees with an exercise price set at a discount to the then current market value of the underlying shares (in some circumstances IHT charges can arise in the EBT); or
  • Employees purchase shares from an EBT for less than market value (CGT charges can arise in the EBT based on the full market value of the shares sold if the trustees are UK resident).

As part of considering whether unexpected tax charges prevent employees being effectively incentivised, rewarded, and engaged, employers should confirm whether their EBTs are currently compliant with their tax obligations and, where appropriate, that they have been registered with HMRC

What happens next?

This consultation closes on 25 September 2023. HMRC will publish a summary of the responses it receives later this year.

Please contact the authors, or your usual KPMG in the UK contact, if you would like to talk through what the proposed changes might mean for you, or if you have any points you would like us to consider reflecting in any consultation submissions that we make to HMRC.