New tax exemptions for companies owned by employee ownership trusts
The growth of employee ownership
Employee benefit trusts or "EBTs" have commonly been used in the UK to act as a warehouse for shares in a company operating a share or share option plan and, in the case of private companies, for creating an internal market enabling employees to buy and sell shares in their employer company. EBTs were also used in tax avoidance structures during the 1990s and early 2000s - it is because of these structures that the UK tax authority, HM Revenue & Customs, can view employee trust arrangements with some suspicion. But another use is now proving popular, with support from the UK Government. This is where a business is owned collectively for the benefit of all those working in it through an employee ownership trust. In this article, "employee ownership" means:
"a significant and meaningful stake in a business for all its employees. If this is achieved then a company has employee ownership: it has employee owners" (The Nuttall Review of Employee Ownership, Business of Innovation and Skills, 2012).
For decades, direct share ownership by employees has been promoted in the UK through a variety of tax-advantaged share and share option plans. Employee trust ownership is also a tried and tested method of running and sustaining a successful business. John Lewis Partnership, one of the UK's biggest retailers, is a great example. It is wholly owned by an employee trust and all of its 93,800 permanent staff are beneficiaries of the trust. Notwithstanding such success stories there has been a distinct lack of awareness of the employee trust ownership model until recently. Hard work and perseverance by interested stakeholders has succeeded in raising awareness of employee trust ownership. In particular, in 2014, the UK Government confirmed its commitment to support employee ownership trusts in a tangible way with the introduction of new tax exemptions.
Capital gains tax exemption
As in many other jurisdictions, any capital gains made in respect of the sale of shares in a company by individuals are subject to tax ("CGT"). In the UK, the rate of CGT can be up to 28% depending on the facts.
The UK Finance Act 2014 introduced a complete exemption from CGT arising in connection with the sale of shares to a new type of trust, an "employee ownership trust" or "EOT". An EOT is essentially a particular type of EBT which has less discretion as to, for example, how trust property can be applied in favour of the beneficiaries. There are a number of conditions that need to be satisfied in order for the exemption from CGT to apply. The exemption does not apply to disposals of shares by a company. The other main conditions are as follows:
- Trading company: the company whose shares are being disposed of ("C") must be trading or the parent company of a trading group (i.e. the exemption does not apply to the sale of shares in investment companies). This requirement must be met at the time of the disposal and for the remainder of the tax year (from 6 April to 5 April the following year) in which the disposal falls;
- All-employee benefit requirement: the EOT must not permit:
(a) any property in the trust (at any time) to be applied otherwise than for the benefit of all employees of C and any group companies (subject to some limited exceptions) on the same terms;
(b) the trustees of the EOT to apply any trust property:
(i) by creating a trust; or
(ii) by transferring property to the trustees of any settlement other than, broadly, another EOT;
(c) the trustees to make loans to any beneficiaries; or
(d) permit the terms of the EOT to be amended in such a way as to permit any of (a) to (c) above,
and this requirement must be met at the time of the disposal and for the remainder of the tax year in which the disposal falls; and
3. Controlling interest requirement: as a result of the disposal (or an earlier disposal in the same tax year), the EOT gained a controlling interest in C. "Control" for this purpose means (broadly) the EOT owns more than 50% of the ordinary shares of C, has the majority in voting rights in C, has the right to more than 50% of profits of C available for distribution and is entitled to more than 50% of C's assets available for distribution on a winding up.
Income tax exemption
Bonus payments made in the UK from employers to their employees are generally subject to income tax (at rates of up to 45%) and national insurance (social security) contributions. The second tax exemption introduced by the Finance Act 2014 is an exemption from income tax (but not national insurance contributions) on qualifying bonus payments of up to £3,600 per employee per tax year. This business model provides a tax benefit to the business and its employees. As with the CGT exemption, certain conditions must be met in order for the income tax exemption to apply.
The main conditions for making a qualifying bonus payment by employer ("E") are as follows:
- Discretionary bonus: it must not consist of regular salary or wages;
- Participation requirement: all individuals employed by E or another group company when a payment is made must be eligible to participate in the scheme pursuant to which the payment is made;
- Equality requirement: every employee must participate in the scheme on the same terms;
- Trading: E must be trading;
- Controlling interest requirement: an EOTmust "control" E (see above); and
- All employee benefit requirement: such EOT must meet the all-employee benefit requirement described above.
The conditions in 5. and 6. above are together known as the "indirect employee-ownership requirement" which must be met throughout the period of 12 months prior to a qualifying bonus payment being made or, if less, the period of time since conditions 5. and 6. were first met in respect of E.
The future of employee ownership in the UK and around the world
Whilst the two new tax exemptions are welcome and go some way to putting employee trust ownership on a par with the tax advantages for direct employee share ownership, tax, of itself, should not drive business structuring. Employee ownership is a tried and tested business model in the UK. Businesses such as the John Lewis Partnership are proof of this. This is what should attract attention to this ownership model. Of course, the new tax exemptions certainly serve to raise the profile of this under-used business model.
Although these new tax exemptions are only relevant to UK tax payers, there is scope for promoting the employee trust model of ownership in other jurisdictions. One of the benefits of employee trust ownership is its flexibility. It can work at every stage of the business life cycle, not just as a business succession solution, and across companies of all sizes and in all sectors.
Jennifer Martin is a Senior Associate in the Tax and Structuring group at Fieldfisher, London. She advises companies and business owners on the full range of corporate tax and since qualifying as a solicitor, she has developed expertise in advising clients and intermediaries on business transformations and tax structuring, both in the public and private sectors often with an employee ownership element.
This article was first published in LawyerIssue on 13th July 2015.