(a) Fieldfisher welcomes the proposal for an ESV to solve long-standing technical issues with the warehousing and market making of shares for use in employee share plans ("ESPs").
(b) The work of the Office of Tax Simplification ("OTS") has (as explained in the 17 July 2014 new ESV consultation document ("ConDoc")) "enabled the Government to undertake the most significant package of reform to the tax rules for ESPs for many years". An ESV will complement these reforms by making it easier (and less costly) for companies to enable employees to acquire and sell shares under ESPs.
(c) The ConDoc also acknowledges that ESPs can be distinct from employee ownership (as defined in the independent Nuttall Review of Employee Ownership in 2012) but are a related area.
(d) As explained in this response we believe the ESV must be flexible enough to form part of a direct employee ownership structure, as well as support minority employee share ownership.
(e) References below to questions are to the questions asked in the ConDoc
The ConDoc is a useful summary of long-standing tax issues encountered when administering an employee share plan.. This response to the consultation supports the ESV proposal to solve these issues and highlights the opportunity it presents in particular:
(a) to create an onshore capital gain tax efficient alternative to an offshore employee benefit trust;
(b) provide a solution to the loan participator charges that can arise when making a loan to a trust; and
(c) to add another governance vehicle into employee ownership structures (provided the ESV can receive dividends and exercise votes)
3. Detailed responses
3.1 The importance of solving the tax issues identified by the OTS
Questions 1 and 9 (and related detailed questions 2-8 and 10)
It is important to take this long awaited opportunity to solve the tax issues identified by the OTS. By doing so the ESV will become the default vehicle for warehousing and market-making existing shares for ESPs. In particular the ESV must:
(i) provide for the capital gains tax ("CGT") free disposal of qualifying securities (as defined in the ConDoc) to participants in ESPs;
(ii) enable a close company to lend money to the ESV without creating a tax charge under the loan to participator provisions; and
(iii) benefit from the existing inheritance tax ("IHT") reliefs available to section 86 IHT Act 1984 trusts ("section 86 trusts") (and ideally to simplified access to those reliefs).
It would also simplify and reduce costs and risks if the other tax issues identified by the OTS could be solved including:
(iv) removing uncertainty over whether or not an advance tax clearance application is needed under the artificial transactions in securities provisions;
(v) enabling share transfers to be registered immediately (rather than incurring the costs and delay of paying stamp duty on stock transfer forms);
(vi) confirming that a "corporate" trustee may hold a controlling interest in a company operating a tax advantaged ESP (without prejudicing the tax status of the ESP); and
(vii) enabling the administrator of the ESV to hold full details of ESP participants without this creating tax charges under the "disguised remuneration" provisions.
3.2 Ensuring adequate safeguards to prevent unacceptable tax avoidance
Question 11 (and related detailed questions 12-22)
Safeguards will be needed to prevent unintended use of the new ESV tax regime. Experience with, for example, share incentive plans and more recently with employee-ownership trusts ("EOTs") shows companies will accept reasonable safeguards, consistent with commercial aims, in order to access tax reliefs and solutions. The safeguards identified by the OTS (and referred to in question 11) are in our view all acceptable (and desirable) safeguards. They also help define and explain the purpose of the ESV.
(i) it is very important commercially that an onshore CGT free solution is established: participants and companies would in our experience prefer a UK based "in house" warehouse and market-making facility for their ESPs. This should not prevent the use of offshore administration services but would help promote ESPs to participants more effectively;
(ii) all former employees should be able to receive shares from and sell shares to the ESV. This provides commercial flexibility to, for example, reward former employees after the ESP participant has left if, there is, say, a key event such as a Stock Exchange listing;
(iii) the ESV must support executive share incentives and so individual participants must be able to receive and sell large percentages of a company's equity. We accept the need for an individual percentage limit and suggest this is the same as now used for tax advantaged share plans (i.e. 30% (see further in paragraph 10, Schedule 4, Income Tax (Earnings and Pensions Act) 2003));
(iv) an ESV could, in effect, be a section 86 trust which has specified "qualifying purposes" (as identified by the OTS) and additional requirements (e.g. the approach taken in relation to defining EOTs);
(v) there must not be a minimum or maximum holding period from a commercial point of view: companies must be free to introduce ESPs that meet the requirements of their business. We do not see the need for this safeguard. Whether an employee acquires shares after 3 years or 10 years if, say, a non-tax advantaged share option has been exercised, the participant will still pay income tax on the option gain;
(vi) the ESV should be able to acquire shares at any price, even a price that proves to be above market value. It is difficult to value shares in private companies and if the ESV is to operate cost effectively it must not be required to establish whether or not it is paying an above market value for shares. It is the seller and the employing company that should deal with the tax consequences of, say, a sale at over market value;
(vii) we believe it would be commercially acceptable to prohibit an ESV from making loans to "beneficiaries" and from creating "sub-trusts" (restrictions that apply to EOTs) if HM Treasury consider this a necessary safeguard;
(viii) it is vital that an ESV may receive dividends and exercise votes if it is to be flexible enough to form part of direct employee ownership structures. This will enable ESVs to operate independently of the boards of sponsoring companies (if this is wanted commercially);
(ix) it is vital that there is no time limit on attributing shares to participants. There is no such constraint on offshore section 86 trusts and if the ESV is to become the default vehicle of choice it must have the same freedom of operation as an offshore section 86 trust; and
(x) it would be important to ensure early take-up of the ESV if existing shareholdings in offshore section 86 trusts could be transferred tax free into ESVs. The transfers should be CGT free but a new specific stamp duty relief would remove this cost from implementing such a reorganisation and encourage existing arrangements to come onshore.
3.3 The importance of basing the ESV on existing models
As explained above, we would prefer the ESV to be designed around a section 86 trust i.e. by adding additional restrictions to those already in place. We support the publication of an approved trust deed for an ESV with supporting HM Revenue and Customs guidance.
3.4 Large potential take-up for ESVs
Almost every company operating an ESP currently needs to establish a section 86 trust at some stage to support that ESP. The default professional advice is to establish that trust offshore to avoid the complexities of dealing with CGT. This means the trust needs professional trustees, which adds to annual costs and prevents an "in-house" solution. In our experience companies prefer to choose who is best to act as trustee, not be limited to choosing professional non-UK tax resident trustees. The ESV will change this default advice and provide an onshore solution.
We have heard repeatedly from offshore trust administrators in recent months that demand has picked up for new trusts to support ESPs. We are confident the demand is there for an onshore alternative.
An ESV should still be able to use offshore administration systems but will not have to pay for the often unwanted non-UK trustee costs.
The ESV will be of benefit to all sizes of company, especially private companies, whether there is a small number of participants or a larger number. It will reduce start-up costs and ongoing administration.
The ESV may also encourage those who would not otherwise consider employee share ownership to introduce it.
The ESV will provide solutions to long-standing tax technical issues and also achieve a major practical change – providing an onshore solution that will not be treated with the suspicion and concern that some employees have about existing offshore trust solutions.
Should you have any questions on this response please contact Graeme Nuttall OBE, Partner, Fieldfisher (email: firstname.lastname@example.org)
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