Proposed tax changes for employee ownership trusts and employee benefit trusts

The Government recently issued a consultation on the taxation of employee ownership trusts (EOTs) and employee benefit trusts (EBTs). The consultation, which opened on 18 July 2023, closes on 25 September 2023. Although the proposed changes look sensible, the proposed removal of the s.464A clearance process is likely to cause some annoyance.

EOTs

What are the proposed changes to reliefs?

The Government proposes that former owners (alone or taken with persons connected to them) should be prevented from retaining control of the EOT. This would be achieved by requiring more than half of the trustees of the EOT be persons who are not the former owners or persons connected to them. Any breach of these conditions after disposal would be a disqualifying event and lead to an immediate capital gains tax charge to the trustees (or to the former owner, if within the first year following disposal).

This restriction would not prevent former owners and connected persons from acting as trustees of the EOT, provided they do not comprise most of the trustees. Special consideration is needed for EOTs controlled by a corporate trustee. This is to ensure that former owners or connected persons (spouses / civil partners and close relatives of the former owners) could not retain control of the EOT via control of that corporate body.

Clearances

Where the company makes a payment to the EOT which is not a loan or advance, it is sometimes necessary to consider the potential for targeted anti-avoidance rules to apply to that payment. It has been common practice to seek clearance from HMRC to confirm that HMRC will not seek to apply this legislation to the company contributions to the EOT.

In general, HMRC does not provide clearances in respect of whether there are tax avoidance arrangements and since both the anti-avoidance rule and the EOT rules have been in place now for almost a decade, HMRC proposes to stop providing clearances in respect of whether there are tax avoidance arrangements in connection with company contributions to EOTs.

To avoid the need for applying for further clearances, the Government proposes to confirm in legislation that contributions made by the company to the EOT trustees in order to repay the former owners for the acquisition cost of the company shares, will not be treated as distributions. This would include associated stamp duty and any interest payable at a reasonable commercial rate. This relief would only apply if the consideration paid by the trustees for the shares does not exceed the open market value for those shares.

Where a close company loans or advances money to one of its participators and this amount remains outstanding, this gives rise to a corporation tax charge. This will continue to apply as normal where a close company makes a loan or advance to an EOT which owns shares in the company (or where the EOT trustees otherwise become indebted to the company).

What other changes do business owners need to be aware of?

The Government proposes:

introducing a requirement that the trustees of an EOT be UK resident as a single body of persons. This would require either the trustees of the EOT all be UK resident or that the trustees be a mix of UK resident and non-UK resident and that the former owner was UK resident or domiciled at the date the shares were disposed of to the EOT. A breach of this condition at any time after the disposal such that a UK-resident EOT becomes non-UK resident would result in a capital gains tax ‘exit charge’
amending the qualifying bonus payment rules so that tax-free bonuses can be awarded to employees without directors necessarily also having to be included. These changes would make the tax-free bonus a key incentive as setting up EOTs will be easier to administer. Any changes will continue to ensure that the bonus payments cannot be weighted in favour of directors and the highest paid, or otherwise be exploited.

The Government is interested in hearing views on whether conditions on EOT trustee appointments should be defined further. To find out more information, click here.

EBTs

There are concerns that some EBTs are being used in ways that are not in line with the policy objective which is to encourage incentivising a wide class of employees. HMRC has seen arrangements where EBTs are set up to meet the conditions for obtaining inheritance tax relief (IHT) but little or no capital is given to the wider class of employees. These EBTs are set up so that participators or their family members can benefit from income earned by the EBT.

What are the proposed changes?

The Government is consulting on reforming the exemptions to protect against this behaviour and ensure the tax treatment of EBTs is in line with the original policy intent.

The Government’s position, as supported by two recent Court of Appeal decisions (Barker v Baxendale Walker Solicitors [2017] EWCA Civ 2056 and Bhaur v Equity First Trustees (Nevis) Limited [2023] EWCA Civ 534), is that individuals connected to a participator cannot benefit for the entire lifetime of the EBT, even after the death of the participator in question.

HMRC has seen cases where the trust deed allows individuals connected to a participator to benefit after the participator’s death. Many EBTs would have been set up in this way, pre-dating the two cases referred to above. The Government proposes to make it explicit that restrictions on persons connected to the participator benefitting from EBT must apply for the lifetime of the EBT.

Presently, an individual can set up a company, make a transfer of shares to an EBT and obtain IHT exemption. The Government proposes introducing a rule where the settlor needs to have held the shares for two years prior to settlement into an EBT in order to gain this exemption.

Finally, when considering whether participators and those connected to them are excluded from benefitting under an EBT, no account is currently taken of income payments made from the EBT. HMRC has seen instances where individuals connected to the participator, who are excluded from benefitting from the capital of the trust, are still able to benefit from the EBT through income payments.

The Government proposes introducing a provision that no more than 25% of employees who can benefit from income payments under an EBT can be connected to the participator for the EBT to benefit from favourable IHT treatment.