For decades, employee benefit trusts (EBTs) have been used to help organisations set money aside for the benefit of their workforce.
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- Employee benefit trusts are tax-efficient discretionary trusts designed to hold employee assets.
- EBT assets may include employer shares and be held in the UK or offshore.
- Some employers are reluctant to use offshore EBTs because of negative publicity surrounding corporate tax avoidance.
But in recent years, such schemes have come under increasing scrutiny from HM Revenue and Customs (HMRC) (see box), which has taken a heavy-handed approach to organisations considered to be trying to reduce their tax bill.
Stephen Woodhouse, a partner in the tax practice at Deloitte, says: “A private employer will often want to have an EBT because it needs to provide a market for people to sell their shares.
“Some public organisations may also have EBTs for this purpose, and to avoid the complexity of using Treasury shares.”
EBTs are also used for mergers and acquisitions.
Andy Goodman, a partner at accountancy firm BDO, says: “An employer could have made a disposal of a business and have a lump sum that is fully taxed and now wants to allocate it to employees. That is put in an outside pot [the EBT], where the directors will no longer be able to touch it.”
EBTs can also protect assets from creditors in the event of an employer going into administration.
In most, but not all, cases, EBTs will be set up offshore.
Nigel Davies, a consultant at law firm Charles Russell, says: “If a trustee is UK-registered and it acquires an asset from an employer to satisfy a future share liability and then the share price goes up and [the trustee] disposes of the asset in settling the option, then technically it makes a capital gain, which could be taxable.
“If it is a non-resident trustee, it cannot make a capital gain that would be taxable, so there is potential for erosion if you have an onshore trustee. The trustee would have to pay the tax liability and the employee would get a smaller profit.”
HMRC should not have an issue with an employer establishing a trust offshore as a means of avoiding capital gains tax (CGT), says Deloitte’s Woodhouse. “If [HMRC] recognises what it is, essentially a holding vehicle, then if an employer has capital gains in the trust and then has a distribution, which is also taxed on the full value, [the organisation] ends up with a form of double taxation,” he says.
Woodhouse adds that if an EBT is used to hold a significant amount of share capital on behalf of a workforce, an employer’s sale of the business could see CGT eat into a significant amount of the proceeds.
Internal share market
Such arrangements are particularly beneficial in cases where the EBT is used to maintain an internal share market, and buys and sells shares regularly.
Graeme Nuttall, a partner at law firm Field Fisher Waterhouse and author of the recent review Sharing success: The Nuttall review of employee ownership, published in July 2012, says: “The fees for paying an offshore administrator soon become worthwhile when [employers] look at the CGT savings.
“That is still a significant push to force trusts offshore. Even those [organisations] that would prefer to set a trust up in the UK often feel they have no choice but to continue to go offshore.”
Where an EBT is designed to hold shares permanently with no real intention of selling them, such as where employees benefit from dividend payments, there is less of a case for employers to go offshore.
“Almost without exception, every trust that my firm establishes for holding shares perpetually is established in the UK, in a UK tax-resident trust,” Nuttall says.
UK-based EBTs may also be more suitable for organisations that bid for public sector contracts, where the use of offshore arrangements can prevent them tendering.
Offshore EBTs remain a useful vehicle for international employers to cope with the issue of expatriate employees.
Nuttall adds: “In the case of an international group, there is a much clearer commercial reason for establishing a trust offshore, in that it provides a neutral basis for dealing with employees around the world.
“It makes it much easier for employers to deal with employees that move from one jurisdiction to another.”
However, employers’ reasons for creating an EBT are more important than the vehicle’s location.
BDO’s Goodman says: “There are tax benefits and reasons for putting EBTs offshore, but I think those are separate from whether the EBT is being used in an aggressive way.
“If an employer is trying to disguise bonuses and payments to employees, whether or not they have the trust located offshore is a sideline.
“Similarly, if a trust is facilitating an internal market for shares and is genuinely located offshore, and the trustees are making decisions from those locations, then that is an innocent use for the EBT.”
Goodman admits some employers would rather not risk the creation of an offshore EBT being misinterpreted as an attempt to avoid tax.
“Often, employers will say they don’t want to be seen to locate an EBT in Guernsey or Jersey, so they locate it in the UK and accept there is a risk of some tax on the trust,” he says. “It feels a little too risky.”
Iain Hasdell: Employee benefit trusts are a popular option for employee ownership
Employee benefit trusts (EBTs) have received much attention over the past few years because of the success of employee-owned organisations such as Make Architects and John Lewis Partnership that have an EBT in their structure. Such businesses consistently outperform their externally owned competitors.
EBTs continue to be a popular option for organisations wanting to implement employee ownership. They can appeal particularly to founding owners who are approaching retirement and who wish to sell their controlling interest in a business to their workforce.
In such circumstances, EBTs can provide an effective mechanism for immunising the business from an aggressive acquisition in future because the shares are held in trust for the benefit of the employees, rather than directly by them. At the same time, an EBT can effectively guarantee that the business is permanently accountable to the employees as the shareholders.
However, an EBT is not the only framework for building an employee-owned business. Many employee-owned organisations prefer the direct ownership model in which staff directly own the business’s share capital. This preference is usually based on a belief that creating a sense of ownership among employees and a culture of engagement and participation is optimised when the employees own the shares themselves.
In addition, a host of employee-owned organisations in the UK use a combination of an EBT and direct share ownership.
EBTs are, and will continue to be, very much part of the employee ownership landscape. Their use is selective and dependent on whether an EBT fits the ethos and approach that the original business owners or creators are striving to establish or preserve.
Iain Hasdell is chief executive officer of the Employee Ownership Association
Employee benefit trusts: A chequered history
A major historic reason for employers using employee benefit trusts (EBTs) was the fact that any money deposited in such vehicles would attract corporation tax relief immediately, despite the fact that employees would not pay income tax or national insurance contributions until the assets were realised. This situation ended in 2005 with a House of Lords ruling against Dextra Accessories, in a case brought by HMRC.
The House of Lords ruled that payments to EBTs could constitute remuneration.
Alongside that, however, such arrangements became used increasingly to make deferred payments to trusts which would then be loaned to employees, often with little intention of them ever being repaid, with only the interest payable on those loans qualifying for tax purposes.
Michael Dawson, managing partner at tax adviser Forbes Dawson, says: “If an employer put £100 into the EBT, it would get tax relief on £100 and the employee would get a loan of £100.
“If the interest benefit was £10, the employer would pay tax at what used to be 40% on the £10, so the employee would pay tax of £4.”
After a number of high-profile cases brought by HMRC, including that involving Rangers Football Club and JP Morgan Chase and Co, which found that funds transferred to the football club’s staff were loans rather than remuneration, the government introduced the disguised remuneration rules.
These came into force in 2010 and impose an immediate income tax charge whenever a trust makes payments or assets available to specific employees, or has ‘earmarked’ them to specific individuals.
“This means employees can no longer get loans without paying tax on the whole amount, not just the benefit,” says Dawson.
He says his firm is currently involved in winding up such schemes for a number of businesses, with HMRC currently offering organisations that had set up dubious arrangements an opportunity to settle.