Employee benefit trusts (“EBTS”) provide a useful tool for companies who wish to enable their employees to participate in their profits (whether through share or cash awards). In addition, EBTs if structured appropriately can be used as a mechanism for providing tax efficient incentives to employees.
What is an EBT?
An EBT is a trust established by the employer (or a company in theemploying group) for the benefit of employees from time to time of the company or group and certain family members. EBTs are discretionary which means that the trustee has the power to appoint the income and capital of the trust fund as it sees fit amongst the employees. The trustee must act in the best interests of the employees taking into account any recommendations received from the employer.
What is the structure of an EBT and how is an EBT established?
The EBT structure is illustrated below. In broad terms, the following steps are involved in establishing an EBT:The employer enters into a trust instrument with the trustee and makes an initial cash contribution (normally £100) to set up the EBT. The trust instrument sets out (a) the parties, (b) the initial trust fund, (c)the length of time the EBT is to last,(d) the terms on which the beneficiaries may benefit and (e) the powers and duties relating to the management and administration of the EBT.The employer subsequently makes contributions (gifts) or loans to the EBT with recommendations as to how the trustee should consider applying those funds.The trustee will consider those recommendations and will act in its discretion to benefit employees.
Why use an EBT?
EBTs are often used in conjunction with an employee share plan to ‘warehouse’ and supply shares to employees as and when those shares are needed to satisfy awards or options made under the plan. Using an EBT in this way has a number of commercial advantages, including:The EBT can be used as a hedge against share price increases by acquiring shares at the same time as options are granted to employees. When the options are exercised, the EBT is in a position to sell shares to employees which were acquired at the price at which they are being sold.The EBT can be used to buy shares on the market rather than acquiring newly issued shares, avoiding the dilution of other shareholders’ interests. EBTs: may also be used to provide deferred cash bonuses. This gives employees the comfort of knowing that the assets held in the EBT are protected from creditors of the employer in the event of the employer’s insolvency. Both share plans and cash bonus plans are a useful mechanism for retaining employees. From the employees’ perspective, the existence of an EBT is often seen as a commitment by the employer to employee share ownership and incentivisation and, if structured correctly, can ensure that employees are not subject to income tax and NIC until they receive shares or cash from the EBT.
Are Treasury Shares better than EBTs?
On 1 December 2003 legislation came into effect allowing companies with shares listed or traded on the London Stock Exchange or AIM (or elsewhere in the EEA) to purchase their own qualifying shares out of distributable profits and hold them ‘in treasury’ for sale at a later date or for transferring them to employees under the terms of a share plan. Prior to this date companies which purchased their own shares were obliged to immediately cancel them. When the treasury share legislation was introduced it was thought that listed companies would use treasury shares to satisfy employee share awards rather than EBTs, with the result that the use of EBTs would be restricted to cash based plans or share plans for unlisted companies which are still required to immediately cancel any own shares which they purchase. In particular, treasury shares were seen as having the following advantages:No trustee fees.No stamp duty on transfers of shares out of treasury (there is 0.5%stamp duty on the transfer of shares from EBTs to employees).On the exercise of options, the company will retain the exercise proceeds. There are a number of circumstances, however, where it may still be preferable to use EBTs:Shares held for the purposes of a HM Revenue & Customs approved Share Incentive Plan (“SIP”) must be held by a trustee in accordance with tax legislation.Where the employing group wishes to be relieved of the administrative burden of operating share plans(see below).Where the terms of the share planned title employees to dividends before they become shareholders (treasury shares do not carry dividend rights).Where the company complies with ABI guidelines and is close to its headroom limits. Under ABI guidelines treasury shares that are reissued to employees count towards the ABI limits. Currently where an EBT transfers shares to an employee the shares do not count towards ABI limits, although there has been recent speculation as to whether the ABI will change its guidelines so that shares transferred by an EBT will also count towards the limits.
Where should the EBT be located and who should be the trustees?
If a company decides to use an EBT, the next issue to consider is where the EBT should be located and who should be the trustees. For cash incentive plans and most share plans (the exception is SIP where the shares must be held by a UK trustee) the EBT can be located either inU+00B7the UK or offshore.
Where the company which establishes the EBT is UK resident, the only way the EBT will be treated as resident offshore is if all of the trustees are non-UK resident. Generally therefore, if it is desired to establish the EBT offshore, this will mean using a professional trustee rather than asking the directors of the company to act as trustees. Whilst offshore professional trustees may seem expensive there are a number of advantages in using them: It will ensure that the EBT is non-UK resident for tax purposes with the result that: There will be no capital gains tax on investment gains (for example on the sale of shares). UK trusts are subject to capital gains tax at 18% on investment gains except in limited circumstances. There will be no UK income tax on foreign source income. UK trusts are subject to UK income tax on their worldwide income at 40% (except for dividends which are taxable at 32.5%). The reporting requirements are less burdensome than for UK trusts. Professional trustees have significant experience in operating share and incentive plans and can offer a fully out-sourced service thereby reducing the administration burden on the employer. Employees prefer EBTs where the trustees are independent of the employer. Professional trustees are normally corporate bodies rather than individuals. This reduces trustee administration since there is no need for deeds of retirement and appointment each time there is a change in personnel.
Victoria Goode, Director of Sanne Group