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Employee Benefit Trust

Do you need advice on an employee benefit trust? EM Law are experts in advising clients on employee benefit trusts. Our employee benefit trusts lawyer is Suzy Giele who has extensive experience in advising clients on a wide range of employee share incentive matters.

What is an employee benefit trust?

An employee benefit trust is a type of discretionary trust established for the benefit of a company’s (or group’s) employees and former employees and, usually, certain of their relatives and dependants.

Employment Benefit Trust trustee is independent and has a duty to act in best interests of beneficiaries

Although an employee benefit trust is established by a settlor company, and the trustee is generally appointed by that company, the trust is independent of the settlor company. This means that although the company can request the trustee take certain actions in relation to the trust, the trustee must exercise its discretion in deciding whether or not to follow the company’s request. In doing so, it must exercise its fiduciary duty to act in the best interests of the class of beneficiaries of the trust as a whole.

Why do companies use employee benefit trusts?

A company may set up an employee benefit trust in connection with a specific employee share plan or event (such as the departure of an employee shareholder), or it may operate a trust over a number of years in connection with a variety of employee incentive arrangements.

Common reasons for setting up an employee benefit trust include:

  • To create a vehicle to acquire and hold a pool of shares to satisfy share awards under a company’s employee share plans.
  • To create an internal market to enable employee shareholders in a private company to sell their shares and receive value.
  • To buy shares from shareholders who are required to sell their shares under the company’s articles of association or shareholders’ agreement, for example, an employee shareholder who leaves the company.
  • Enabling the deferral of employee bonuses, whether in cash or shares. In particular, UK employers in the financial services industry are generally required defer a proportion of senior employees’ bonuses under the remuneration code.
  • To provide a vehicle to enable the company to become wholly or partially employee-owned.

Establishing an employee benefit trust

There are a number of legal and practical considerations to take into account when establishing a new employee benefit trust. These include:

  • Where the trust (and the trustee) will be resident; this will affect the taxation of the assets held in the trust.
  • Whether to appoint a professional corporate trustee or a group of individual trustees.
  • How the trust will be funded (either by loan or gift).

Running an employee benefit trust

Once an employee benefit trust is established, it will generally be run for a number of years (and it is possible, although unlikely, that it may run for the full perpetuity period specified in the trust deed). During a trust’s life, the trustee and the settlor company will have ongoing technical and administrative responsibilities in relation to the trust (and the trustee may decide to take independent legal advice regarding its responsibilities), including:

  • Making and dealing with additions to the trust fund.
  • Removing an existing trustee (or dealing with its retirement) and appointing new trustees.
  • Making recommendations to the trustee regarding the disposition of the trust fund.
  • Keeping records in relation to the trust.
  • Making trust tax returns to HMRC (if required).

Taxation of employee benefit trusts

Income tax

UK-resident employee benefit trusts

A UK-resident employee benefit trust is within the scope of UK income tax. It will be subject to UK income tax on all its trust fund income.

The trustee is not entitled to personal allowances. There are pooling rules for income accumulated by trustees, and the tax bands and rates are set against this pooled income in a set order.

Non-UK resident employee benefit trusts

A non-UK resident employee benefit trust is outside the scope of UK income tax, except in relation to UK-source income (most commonly dividends paid on shares in UK companies). Any UK-source trust fund income is subject to UK income tax at the same rates as for UK resident trusts, and the same pooling rules for tax on accumulated income apply. The trustee is not entitled to UK personal income tax allowances.

Payments of employment income: income tax relief for trustees

The UK-resident trustee of an employee benefit trust may be able to claim relief for income tax on distributions made out of accumulated income, if the receipt is taxed as employment income in the beneficiary’s hands. There are various conditions for the relief to apply, and if available, it applies to adjust the trustee’s tax pool for the relevant tax year.

Capital gains tax

A UK-resident employee benefit trust is within the scope of UK capital gains tax (CGT). It will be subject to CGT on all trust fund gains. The trustee is entitled to a CGT annual exempt amount that is half the rate of the individual annual exempt amount.

A non-UK resident employee benefit trust is outside the scope of UK CGT altogether. This is often a significant factor in choosing where to establish an employee benefit trust.

Disposals that are employment income: CGT relief for trustees

The UK resident trustee of an employee benefit trust may be able to claim relief for CGT on the transfer of an asset, if the asset is liable to income tax as employment income in the beneficiary’s hands.

Inheritance tax

An employee benefit trust that is established as an employees’ trust under section 86 of the Inheritance Tax Act 1984 (section 86 trust) is exempt from the following IHT charges on relevant property trusts:

  • The ten-yearly charge on the value of assets in the trust fund.
  • The exit charge on the value of assets leaving the trust fund.

However, an employee benefit trust is not exempt from (and therefore potentially liable for) IHT charges under section 72 of IHTA 1984. In HMRC’s view, these apply to transfers to sub-funds (see below) and may also be an issue for grants of share options at less than market value.

Close companies

Close companies need to consider additional tax issues, including:

  • A possible IHT charge on certain transfers of assets to an employee benefit trust by a close company.
  • A possible corporation tax charge on any loan to a participator (including an employee benefit trust) by a close company that remains outstanding nine months after the end of the accounting period in which it was made.

Taxation of contributions to an employee benefit trust

Broadly, contributions by a company to an employee benefit trust are deductible for corporation tax purposes provided the amounts are paid out as “qualifying benefits” (or expenses of the trust) within nine months after the end of the accounting period in which the contributions are made.

In order for relief to be given, the contributions must be:

  • Revenue, not capital, in nature.
  • Wholly and exclusively for the purposes of the company’s trade.

 For any questions you may have concerning an employee benefit trust contact Suzy Giele.

Employee Benefit Trust Lawyers EM Law Suzy Giele

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