What follows is my response to HMRC’s open consultation on EOTs published on 18^th July 2023

References to Chapters are to chapters of the Consultation Document published on 18 July 2023.

• Your Chapters 2 & 3: What is the underlying policy objective?

The stated policy objective, namely “to encourage and incentivise the growth of employee ownership as a viable and mainstream business model” and “[for trustees to be] bound….to apply the trust property for the benefit of all the eligible employees….” is, to my mind, more of a stated means to an end, rather than a policy end in itself. One has to ask: what is the benefit intended to be derived by individual employees from their employer company being owned and controlled by trustees rather than by any other investors? If the answer is that investment returns are intended to be enjoyed by employees as well as by financial investors, that is not in fact what happens, or is enabled to happen, by the legislation (s236H et seq TCGA 1992) as it stands.

Supporters of the indirect (trust) ownership model are keen to talk up its advantages, over other forms of private ownership, but are unable to explain how individual employees benefit financially from capital growth in the value of the business as compared with such other models. If the policy is “to encourage the ownership and control of a business on a collective basis”, one has to ask to what end? The difficulty with the “John Lewis Partnership” model of collective ownership, through the use of employees’ trusts, is that it is not apparent who benefits from growth in capital value of the company. (Quaere: what will happen to the ownership of The John Lewis Partnership if the trust period(s) comes to an end and is not extended by a private Act of Parliament?)

There appears to be a view on the part of policymakers that a business which is collectively owned and controlled by trustees of a trust for the benefit of employees is more likely to be economically successful than one which is owned and controlled by investors owning beneficially and who do not owe fiduciary duties to employees of the business. There is little or no hard statistical evidence for this. The success of a particular business may owe more to the skills of its management than to its collective ownership structure. In my experience, employees benefit financially more by being enabled to acquire and sell shares and, in those cases in which all employees participate, the personal engagement which this engenders produces tangible improvements in business performance.

The idea, that entrenching collective ownership for the benefit of employees is of itself “a good thing”, undermines the free-market notion that a business may thrive under the ownership of any one of a range of different acquirors. Ownership by an employees’ trust is neither a guarantee of success nor, given the obvious constraints upon raising capital from its trustee shareholders (or employees), does it enable a company to grow in the same way that it could if beneficially owned by individual, corporate or private-equity shareholders.

Under the existing regime, the ways in which individual employees are able to benefit personally from working for an EOT-owned company are limited.

• tax-free bonuses may be paid annually to all qualifying employees through payroll;
• the company could operate a tax-advantaged employee share scheme using newly-issued shares (or shares purchased into a separate employees’ trust from other shareholders) and adopt a mechanism for allowing leavers or those who wish to do so, to sell back their shares to any of (i) the company, (ii) the EOT or (iii) the separate employees’ trust;
• the company could pay dividends to the EOT which then distributes the net-of tax amount to beneficiaries (taxed as employment income); and/or
• the EOT trustee(s) could sell the company or its business and distribute the net-of-CGT proceeds to eligible qualifying beneficiaries (again, taxed as employment income).

Even assuming that the trustee(s) determine to adopt any such policy, none of these courses of action treats individual employees or ex-employees for tax purposes in a manner which is similar to that in which shareholders (including employee shareholders) of a company which is not owned by an EOT are treated. In the case of (a), (c) and (d), the proceeds will invariably be subject to employment taxes, not CGT, and, in the case of (b), the fact that the company is majority-owned and controlled by an EOT means that the market value of small employee shareholdings will inevitably be suppressed by the policy (of HMRC) of applying a substantial discount to the pro rata value of shares in a company when determining the market value of such a small holding. In the case of (d), it is in practice too often the case that, after payment of CGT and of the balance outstanding of deferred consideration due to the original vendors of shares to the EOT, the remaining proceeds available to beneficiaries of the EOT are relatively small and do not reflect the growth in capital value generated whilst the company was owned and controlled by the EOT.

If the underlying policy objective was to afford a tax-efficient means by which the individual proprietors of a company could realise the value they had generated and enable them to do so using the company’s own accrued profits and reserves and without ceding control to a trade buyer or other investors, then the EOT regime may be counted a success. It has encouraged the disposal of shares in many private companies by its generous exemption from CGT. For those proprietors in a position to pass ownership and control to trustees, whilst preserving the ability of the business (at least until the consideration is paid in full) to generate profits sufficient to justify the price agreed to be paid by the trustee(s), the exemption means that a sale to an EOT – as opposed to a trade buyer or private-equity fund, etc. – is a “no-brainer” in terms of maximizing the return on sale.

(A sale to an EOT for a consideration to be paid out of the distributable profits of the company, as opposed to a sale to a third party funded otherwise than by the profits of the company, raises the following conundrum: how can a company, valued at say £10m, be worth that amount to an EOT if that value will be reduced by the cash required to fund the EOT to pay the consideration? A company worth, say, £10m to a third party purchaser cannot be worth that same amount to an EOT purchaser if the consideration reduces the assets of the company being sold.)

What, then, should be the underlying policy objective and how could that be achieved?

I suggest that the policy objective ought to be “to enable employees to share in the growth in value of the business to which they contribute by their labour”. The current tax regime for EOTs does not achieve that.

In my experience – having advised upon and devised the ownership structures of multiple employee-owned companies beginning with the privatized bus companies in the early 1980s – the most successful (in terms of resulting in substantial growth in value) private company ownership structures are those which:

• have enabled individual employees to benefit financially, from an appropriate share in the growth in value to which they have contributed by their labour over the period of their employment, and to do so in a manner which is taxed in the same way as if such gain was realized by a non-employee shareholder; and

• have a corporate governance structure which, whilst allowing the views of employees to be identified and taken into account, includes sufficient checks and balances to ensure that the directors are free to manage the business in the best interests of all shareholders.

So, in my opinion, the policy behind the tax legislation should be to balance the interests of company proprietors so as to offer them a financially viable alternative to selling the company to a trade buyer or to private-equity or other investors, with those of employees from time to time who should be enabled to benefit from the growth in value to which they contribute and to do so in a manner which is taxed no less favourably than if they were private investors and not employees.

As things have stood since 2014, the balance is firmly in favour of the vendor proprietors who are afforded total exemption from tax, and with little or no opportunity for employees (supposedly those persons for whose benefit the EOT regime was enacted – the clue being in the title!) to benefit, other than by limited enhancement to their taxable employment income.

To redress that balance, I would suggest the following changes (each of which is considered in more detail below):

1. Restrict relief from CGT for disposals of shares to an EOT to no more than the market value of the respective holdings of shares sold by claimants to the EOT.

• Remove the tax-free annual bonuses and, instead, provide an exemption from income tax on the part of EOT trustees for dividend payments received from the EOT-owned company if:

• the dividends are paid out to employees on an “all-employee and similar terms” basis; or

(b)   the dividends are retained by the EOT trustee(s) and applied (within, say, 3 years) in the purchase of shares in the EOT-owned company from employees who leave or who, with the agreement of the trustee(s) wish to sell having held such shares for a minimum period (of 3 years?) for a consideration which does not exceed the pro rata value of such shares determined by reference to the “market value” of the company as a whole as agreed with HMRC SAV (or certified by a recognized share valuer).

3.     Provide that payments made to employees (and ex-employees who have left for whatever reason within the past 12 months), as described at 1(a) above, are taxed as dividend income, not as earnings.

4.     Amend Chapter 3D of Part 7, ITEPA 2003 so as to provide that disposals of ordinary shares in the EOT-owned company beneficially owned by employees to the EOT for a consideration which does not exceed the pro rata market value described at 1(b) above is taxed as capital gain, not as employment income.

5.     Allow ordinary shares in the EOT company to be appropriated to employees and/or sold to employees by way of awards under a tax-advantaged Share Incentive Plan (per Sch 2, ITEPA 2003) without that being a disqualifying event, and for so long as such shares are beneficially owned by individual employees and held in the SIP, allow those shares to be counted towards the percentage ownership of the share capital of the company by the EOT (so that the aggregate of such SIP shares, together with those beneficially owned by the EOT must not fall below 50% + 1 if a disqualifying event is to be avoided).

The combination of such changes, together with the changes to SIPs which have been separately suggested in response to the Call for Evidence on SIPs and SAYE share options, would enable an EOT-owned company to allow its employees to benefit directly from sharing in the growth in value of the EOT-owned company over the period of their employment in a tax-advantaged manner (within the confines of a SIP).

The suggestion at 4 above would afford a commercial freedom to allow an EOT-owned company to enable its employees to benefit from such growth in value, subject to CGT, by way of other (existing) mechanisms for the acquisition and disposal of employee shares (such as the grant and exercise of EMI and CSOP, as well as “unapproved”, share options to subscribe for new shares or the operation of an internal market in employees’ shares).

• Your Chapter 4: The EOT trustee(s) and trustee directors

Offshore trustees

It would appear to be obvious that, if the UK is now permitted to do so, it should amend the EOT legislation so as to restrict the persons who may act as trustees of an EOT, and trustee directors of a corporate trustee of an EOT, to persons who are UK residents.

Offshore trustee services organisations may complain, but it is difficult to see why it is appropriate for an EOT to have as trustee an offshore independent trustee services organization whose experience is typically that of acting as a custodian of a minority shareholding and share scheme administrator, as opposed to acting in the role of controlling shareholder. In any event, there is no restriction upon such organisations choosing to establish a UK resident subsidiary to act as trustee of an EOT (as some do to act as trustee of share incentive plans).

The point made that such a change would deny access to the expertise of a non-UK resident individual is not valid: such expertise could be accessed in other ways and, in any event, the inclusion as a trustee director of a non-resident individual does not mean that the trust is itself outside the scope of the charge to UK CGT.

Vendor control

It is difficult to see why individual vendors of shares to an EOT should retain control of the EOT by way of being a majority of the trustees or having control of the board of a trustee company. Their expertise can be made available to the EOT-owned company by having the vendor retain a set on the board of that company or engaged to provide consultancy services.

That said, vendors who sell on a deferred payment basis have a legitimate interest in securing that both the EOT-owned company and the trustee(s) will take all appropriate steps to ensure that the EOT is put in funds to enable the balance of consideration to be paid sooner rather than later.

 Deferred consideration is necessarily unsecured. Given that the EOT-owned company cannot (to avoid a charge to tax on receipts of the EOT) be under a binding contractual obligation to put the EOT in funds, the vendors need to establish other means of ensuring that the board of the EOT-owned company gives precedence to funding the EOT over other application of profits. In my experience, this is the principal, if not the sole, reason why vendors are keen to retain control of the EOT and of the EOT-owned company at least until they are paid in full.

Such control by the vendors can be achieved in a number of ways, such as:

• acting as the individual trustees or trustee directors and ensuring that (a) they comprise a majority and (b) that decisions of the trustees or the trustee directors, are taken by a simple majority;
• retaining a “golden share” in the EOT-owned company which affords the holder(s) a form of negative control of the EOT-owned company;
• remaining as directors of the EOT-owned company and ensuring that they comprise a majority of the board;
• including as a term of the sale and purchase agreement of the shares a provision which imposes a contractual restriction on expenditure by the EOT-owned company (including the payment of tax-free bonuses) so as not to impair the ability of that company to fund the EOT.

The need for independent trusteeship

Given the inherent conflicts of interest of vendors, managers and trustees/trustee directors, EOT trust deeds necessarily include provisions which authorize decision-making by trustees/trustee directors notwithstanding the fact that they might have distinct and conflicting roles and personal interests.

Is there not a case for including, as a relief requirement, both (a) a provision that the trustees/trustee directors must include one or more individuals (or trustee services organisations) who are independent of the EOT-owned company i.e. are not and never have been an officer or director, or 5%+ participator in, that company and any associated company and (b) a further provision that resolutions of the trustees/trustee directors may only take effect with the positive consent of at least one such independent trustee/trustee director. [See, by way of example, paras 3-3C of Sched 5, FA 1989 – re trustees of QUESTs.]

Compulsory inclusion of employees as trustees/trustee directors

Such a provision was not a success when legislated for in relation to QUESTs – see Sched 5, FA 1989. It is surely a commercial matter for the company concerned and its proprietors (and/or the trustees) to determine, as a matter of corporate governance, whether and to what extent individual employees who are not themselves officers or shareholders should be appointed as trustees or trustee directors and, if so, how they are to be selected, nominated, appointed and removed (etc.).

The corporate governance structures of an EOT-owned company

In establishing the checks and balances between the trustees/trustee directors, the vendors, the directors of the EOT-owned company, other shareholders, and employees, guidance is provided – and in my experience is often looked to as a starting point – by the Model Documentation for a Company with Employee Ownership published in 2013 by the Dept for Business and still available at : https://tinyurl.com/7vzdzuwm .

It is regrettable that HMT and the successor to the Dept for Business have not liaised and commissioned and published updated model documentation suitable for use in relation to an EOT. Could this now be done, please?

• Your Chapter 5: Allowing loan funding by the EOT-owned company to the EOT

The commercial imperative for vendors to retain control would be lessened by allowing the EOT-owned company to advance money on loan to the EOT without that giving rise to a charge to tax under s455 CTA 2010 (“loans to participators”). This would allow the EOT-owned company to obtain a bank loan (secured on the assets of the EOT-owned company) which could be applied in making a loan to the EOT, allowing it to pay the agreed consideration to vendors in full. This would have the following consequences:

• It allows the purchase by the EOT to be more easily externally funded and affords greater transparency in a determination of the market value of the shares being sold (as the value of the company must reflect its debt obligations).
• It allows the vendors to “walk away”, having been paid in full up front, and therefore having no commercial need (other than safeguarding the future of the business) for retaining control of the EOT or the EOT-owned company (which avoids the BPR issue identified at 6 below).
• If such a loan by the company to the EOT is free of interest and left outstanding, the company’s debt to the bank can be paid out of funds generated by the business without the need for funds to pass up through the EOT.
• It would make it easier for bank funding to be obtained as banks are more reluctant to lend to the EOT itself (if the funds advanced are immediately paid out to the vendors) even if they can take security by way of a charge over the shares held by the EOT as, again, there can be no binding obligation on the part of the EOT-owned company to put the EOT in funds to service the debt of the EOT and, in any event, contributions to the EOT can only be made out of distributable reserves of the EOT-owned company.

Whilst I recognise the reluctance of HMT and HMRC to make any exceptions to the effective prohibition on loans to participators, it would be relatively straightforward to provide safeguards by restricting any such loan to the initial market value of the shares purchased by the EOT or, if less, the aggregate and specified amount of consideration agreed to be paid for them, and the stamp duty/SDRT thereon.

• Legislating for contributions by the EOT-owned company to the EOT, up to the amount of the lesser of market value of the shares acquired and the consideration agreed to be paid (plus stamp duty/SDRT thereon), to be exempt from tax in the hands of the EOT trustee(s)

HMRC’s long-standing practice of not treating contributions to the EOT as taxable distributions was first confirmed to the ESOP Centre by Dr Victor Baker of HMRC at a meeting in or about April 2014. Dr Baker confirmed in a letter dated 8 May 20154 that it was his intention to amend the HMRC Company Taxation Manual to reflect this, but this has never been done.

Whilst I accept that there is a good policy reason for restricting this practice to EOTs which have paid no more than market value for a controlling interest in the company, it is difficult to see why the treatment should be confined to EOTs, as opposed to other forms of employees’ trust intended to be used to hold a controlling interest in a trading company. Perhaps for this reason it would be preferable to amend the published guidance to reflect the practice of HMRC rather than make a legislative change which applies only to EOTs?

• Allow Business Property Relief from inheritance tax (“BPR”) for unsecured vendor-loan funding

I am aware of a number of situations in which a transfer of ownership of a company to an EOT has been vetoed by elderly shareholders concerned at the loss of BPR when exchanging shares for an unsecured debt obligation by the EOT trustee(s) for the deferred consideration. This has the effect of discriminating against older individual shareholders whose estates will suffer disproportionately if they die before the consideration is paid in full.

• Section 464A CTA 2010

Applications for clearance that this provision would not apply have only ever been “for the avoidance of doubt”. A change to the published guidance to make clear in what circumstances HMRC might seek to apply this provision in the context of an EOT would be welcomed.

• Your Chapter 6: Payment of tax-favoured annual bonuses to employees

The idea that the directors of the EOT-owned company should be entitled (unless restricted by the articles and/or the SPA) to award tax-free bonuses to all qualifying employees each tax year has always seemed perverse, at least from a policy point of view. I understand that it came about because, in a typically “Yes, Minister” fashion, the wrong question was asked of the wrong decision-makers (finance directors having been asked if they would find it easier to administer payments to employees if they were to be made through the payroll – to which the obvious answer was “yes”).

Allowing control of such payments to employees (not being linked to profit) as a payroll expense sets up a tension between the directors of the EOT-owned company (who may see immediate HR and incentive benefits in making such payments) and the trustee(s) who may prefer the money to be applied in making a contribution to the EOT to enable it to satisfy outstanding consideration due to vendors. Further, such payments can be made notwithstanding that the business is loss-making, so they are not necessarily payments by way of sharing in the growth in value to which employees have contributed.

I suggest that, logically, it would be preferable to afford exemption from income tax on the part of EOT trustees for dividends paid by the EOT-owned company, provided that such dividend income is distributed to employees (on an “all-employee, same terms” basis) within, say, 30 days, and for such payments to employees to be treated, for tax purposes, as dividend income, not as employment income.

Such payments to employees need not be capped in amount as they would be dependent upon the EOT-owned company generating the profits required to fund the dividends. It would allow employees to benefit from the value they help create by participating in profits in a manner which is taxed on the same basis as other individual shareholders of a private company. There would in principle be no loss to HMT as the payments would not (as they do at present) reduce the profits of the EOT-owned company for corporation tax purposes.

Excluding officers

The flexibility to exclude directors and other officers from participation in bonus payments would be welcomed.

Overseas employees

What is the policy reason for insisting that employees outside the charge to UK income tax must be included as participants in a (UK) tax-free bonus distribution? Typically, they would be taxed in the country of residence and so here is no obvious benefit to them in receiving the bonus under such a scheme of distribution intended to secure UK tax benefits. It also gives rise to difficulties where:

• the relative value, in terms of the buying power of a given amount, of the payment differs from one jurisdiction to another and this leads to unfairness as between employees around the world;
• differences in local employment laws mean that it can be difficult to identify exactly who is to be treated as an employee for this purpose: an individual taxed as an employee in one jurisdiction may not be an employee for UK tax purposes, and vice versa.

For these reasons, I suggest that the payment of tax-free bonuses be limited to employees whose earnings are charged to UK income tax because they are resident here or they perform duties in the UK. This would greatly simply the administration for those EOT-owned companies with overseas employees.

• Your Chapter 6, question 8 – other reforms

CT relief for share option gains

There is no CT deduction available to an EOT-owned employer company on the exercise of share options by employees of an EOT-owned company (unless the trustees are all individuals).  Was this a deliberate policy decision or an accidental omission?

The EMI share options “trap”

Prior to 2014, it was not uncommon for trusts established to acquire indirect employee ownership of a company to have, as a sole corporate trustee, a company with a share capital which is directly wholly-owned as a subsidiary of the trust-owned company. Such circularity of ownership (i.e. the trust owns the company which in turn owns the trustee) had a number of commercial attractions including the ability to build into the corporate governance structure a range of “checks and balances” to ensure that no one group of interests (vendors/ trustee(s)/trustee directors/ directors of the trust-owned company and its subsidiaries/ employees) could take effective control of the ownership and control of the company.

 Although special provision is made in the legislation for EOT-owned companies to be able to grant EMI share options as rights to subscribe for new shares, an EOT with a corporate trustee with a share capital which is owned in this circular manner cannot grant EMI share options as the grantor company would not meet the “qualifying subsidiaries” requirement in Sch 5, ITEPA 2003.

Allowing capital distributions to beneficiaries to be taxed as capital gains, not employment income.

It does seem contrary to the presumed policy intention of allowing employees to benefit from capital growth in value of an EOT-owned company that, if the company or its business is sold and the net proceeds distributed to beneficiaries, these are taxed as employment income, not as capital gains.

Why should employee beneficiaries of an indirectly “employee-owned” company be taxed in a manner which is substantially worse than that of individual direct share owners? I say “substantially” because the effect of the CGT clawback charge on the EOT trustee(s) coupled with the net proceeds being charged to income tax and NICs in the hands of the beneficiaries, means that growth in capital value of the shares held by the EOT is effectively subject to double taxation.

Allow ex-employees who have contributed to growth in value to participate in distributions

Presently, unless the EOT-owned company or its business is sold, ex-employees cannot participate in a distribution from the EOT. This is grossly unfair. There are many situations in which a long-serving employee who has contributed to growth in value retires, as anticipated, shortly before a distribution and is then excluded notwithstanding that his or her contribution to that value creation far exceeded that of more recent joiners.

The class of beneficiaries in whose favour the EOT trustee(s) should be permitted to (and must) exercise their dispositive powers should be extended to include former employees (including the personal representatives of deceased employees) who have ceased employment within, say, the past 3 years and who had a qualifying period of continuous employment which is no less than the that applied to current employees.

Restricting CGT relief to exemption from CGT on gains representing consideration of an amount not exceeding the market value of the holding of shares sold

It is perhaps surprising that this was not included in the 2014 legislation. Thought is needed as to whether the restriction on relief should be by reference to market value determined on a pro rata basis or upon the lower market value of each holding of shares respectively sold by each vendor. The trustee(s) have a duty under trust law not to acquire the shares for a consideration which exceeds the market value of the aggregate holding acquired (and to be confident of their ability to meet their contractual obligations in doing so). However, it seems overly generous to allow each individual vendor a complete exemption from CGT insofar as the consideration paid to him or her (on a pro rata basis) exceeds the market value as discounted from a pro rata value to reflect the size of the minority holding actually sold to the EOT.

Maintaining a balance between relief from CGT and public benefit

The complete exemption from CGT afforded to certain sales of shares to an EOT has the effect of inducing the establishment of EOTs and the sale of a controlling interest to the trust solely, or primarily, to secure the tax relief. If the consideration agreed to be paid by the EOT (an amount which, in practice, is often determined on a “generous” basis) cannot in fact be funded out of distributable reserves and profits generated in future, the fact that the trust deed and SPA will (or should) provide that the liability of the EOT trustee(s) is on a “non-recourse” basis (i.e. they are only liable to pay deferred consideration if and insofar as the trustee(s) is in funds to enable it to do so and there is no recourse to the trustees personally or to the EOT-owned company) means that vendors can, in effect, fix the consideration at a level at which they can “milk” the company to the extent that it is able to generate distributable profit. If and insofar as it cannot or does not, the vendors are no worse off than if they had agreed a lower consideration, which could be funded by the company, in the first place. The vendors are in the position of “heads they win”, but “tails they do not lose”.

Pu another way, it might be said that the regime is self-policing in that, only if the company can generate the profit will the vendors be paid, but the effect is to encourage values being ascribed to shares in a company which in other contexts would be hard to justify. (See also the point made above about the valuation conundrum where the consideration is funded out of the assets of the company rather than from the pockets of a third party purchaser.)

I would suggest that the relative attraction of the tax relief could be eased, so as to encourage a more balanced approach to proprietors deciding whether to sell to an EOT or a trade purchaser or other third party, if the relief were limited to a reduced rate of CGT, rather than complete exemption.

Counting shares awarded by the EOT, out of its 51%+ holding, to employees under a SIP to count towards the 51%+ holding which it must maintain to avoid a “disqualifying event”

Except insofar as shares first acquired by the EOT in circumstances qualifying for the relief from CGT pass outside the confines of a circle comprising (a) the EOT trustee(s); (b) the company itself (in treasury); (c) employees with a beneficial interest in the shares held by SIP trustees subject to a SIP, the shares should count towards a 51% + 1 minimum holding to avoid triggering a disqualifying event.

This would encourage EOTs to enable employees to acquire direct beneficial ownership of shares whilst maintain the “employee-owned” status of the company.

Going further and making the award of shares under a SIP a requirement of relief from CGT on sales to an EOT

It may be difficult in practice to do so, given that the number of shares available may not be sufficient to allow SIP awards to be made to all qualifying employees on a regular basis or at all.

1. Other enhancements to the EOT regime worthy of consideration

The existing regime would become more attractive to proprietors and employees if:

• there was an exemption from stamp duty/SDRT on sales of shares to an EOT (whether or not such share sales satisfy the CGT relief requirements;
• contributions by an EOT-owned company to the EOT were treated as deductible expenses for corporation tax purposes.

………………………………………………………………….

David Pett     Temple Tax Chambers                                                                                  

17^th August 2023

HMRC has today, 14th October 2022, published its long-awaited revised guidance on the use of discretion in EMI share options. This is the product of much “toing-and-froing” between HMRC and the Share Plan Lawyers, but does not alter either HMRC’s long-established practice or, insofar as it may be relevant, the position in law. The new guidance can be accessed here: https://www.gov.uk/hmrc-internal-manuals/employee-tax-advantaged-share-scheme-user-manual/etassum54300

Budget announcements on 23^rd September 2022

These include:

Company Share Option Plan (CSOP) – From April 2023, qualifying companies will be able to issue up to £60,000 of CSOP options to employees, double the current £30,000 limit. The ‘worth having’ restriction on share classes within CSOP [presumably a reference to para 20, Sch 4, ITEPA 2003 – requirements as to other shareholdings] will be eased, better aligning the scheme rules with the rules in the Enterprise Management Incentive scheme and widening access to CSOP for growth companies.

This suggests that the class of shares to be put under CSOP options need not be either “employee-control” shares, or “open market shares”, allowing qualifying companies to grant CSOP options over a special class of restricted employees’ shares.

(There is no appetite then for enhancing the EMI share option regime.)

Repealing off-payroll working reforms – The 2017 and 2021 reforms to the off-payroll working rules (also known as IR35) will be repealed from 6 April 2023. From this date, workers across the UK providing their services via an intermediary, such as a personal service company, will once again be responsible for determining their employment status and paying the appropriate amount of tax and NICs.

Reform of EMI share options? No….but perhaps a reform of CSOPs.

The Spring Statement, published today (23^rd March 2022) includes the following passage, extracted from para 4.60:

“At Budget 2020, the government launched a review of the Enterprise Management Incentive (EMI) scheme, to ensure it provides support for high-growth companies to recruit and retain the best talent so they can scale up effectively, and to examine whether more companies should be able to access the scheme. The government has concluded that the current EMI scheme remains effective and appropriately targeted. However, the scope of the review will be expanded to consider if the other discretionary tax-advantaged share scheme, the Company Share Option Plan, should be reformed to support companies as they grow beyond the scope of EMI.”

So…are we to assume that there will be no change to the current EMI regime (in place in substantially the same form since 2000), but that attention will now focus instead upon the CSOP regime? Or is this simply an excuse for the Treasury not having had sufficient resource to give the responses received, to the Call for Evidence, the attention they justified?

(Click here for my response to the earlier review of EMI share options referred to above.)

Claritax Books has just published the first edition of my latest book, Employee-Ownership Trusts. So far as I am aware, this is the only published work that focusses on the tax treatment of EOTs and associated transactions, as well as their structuring and financing.

Corporate trading businesses which are owned by trustees on behalf of employees can enjoy greater levels of employee engagement, offering the potential for higher productivity and more even distribution of the resulting financial rewards.

To achieve these goals, the owners of a company can sell their shares to an employee-ownership trust (EOT) for the benefit of the employees. When correctly carried out, this affords CGT relief for the vendors on the sale to the trust and allows the company to pay tax-free bonuses to all its employees.

Interest in employee ownership in general, and in the EOT model in particular, has grown rapidly in recent years. The conditions for gaining the tax benefits are complex, however, so this timely volume offers an accurate and comprehensive guide to the relevant rules.

For more information, please visit http://claritaxbooks.com

The government announced in the 2020 Budget that it would review the EMI share option scheme to ensure it provides support for ‘high-growth’ companies to recruit and retain talented employees and examine if a wider range of companies should qualify to grant EMI share options. To this end a “Call for Evidence” was published by HM Treasury in March 2021 (see: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/965555/Enterprise_Management_Incentives_Call_for_Evidence_2021.pdf ).

Click here to download David Pett’s response to that Call for Evidence. It sets out a number of suggested changes which could be made to the EMI Code to make it easier for qualifying companies to make best use of the tax-advantaged grant of EMI share options and to remove existing “traps for the unwary”.

The response will be of interest to anyone advising a company or its shareholders on the adoption of an EMI scheme or the grant of EMI share options.

I have written to the Sunday Times in response to their article published on 21 March:

Dear Sir,

The article “It’s not just the rich that avoid tax: it’s teachers and nurses too” (March 21) is a fine example of lazy journalism, the content having been gleaned from an HMRC corporate report (https://www.gov.uk/government/publications/use-of-marketed-tax-avoidance-schemes-in-the-uk/use-of-marketed-tax-avoidance-schemes-in-the-uk ) and relayed without challenge. The idea that all lower-income workers involved in arrangements of the type described should be treated as deliberate “tax avoiders” is absurd, given that (a)  it has often been a condition of securing paid work that they do so; (b) it has been falsely represented to them by supposedly reputable organisations that the arrangements have been approved by counsel and by HMRC; and (c) it is unreasonable for HMRC to assume that such individuals have a sufficient understanding of the complexities of our tax laws to appreciate that they are being lured into tax avoidance. This is all the more disturbing, given allegations that HMRC has itself engaged workers paid through such arrangements.

As the HMRC report recognises, the promotion of tax avoidance is not, on its own, a criminal offence. Until it is, it is difficult to see how the government will succeed in preventing ordinary people falling victim to the organisations profiting from the misunderstanding of workers intent on securing remunerative work. Your journalist should perhaps be asking government why, according to recently published consultation documents, it still does not propose to criminalise the involvement of individual officers, directors and company owners in such promotion. To establish guilt, it could be provided that a judge or jury is asked to determine if an arrangement has been “promoted”, once the Upper Tier Tax Tribunal or the High Court has determined, on application by the prosecuting authority, that the arrangement is or involves “abusive tax avoidance”.

Yours faithfully,

David Pett

BBC Radio 4’s “Money Box”[1] programme has investigated unscrupulous ‘umbrella companies’ targeting those retired nurses and other NHS staff returning to work to assist in the response to the Covid-19 pandemic, as well as new hires for the ‘track and trace’ system. I was asked to respond to questions from the presenter, Paul Lewis, about the tax consequences, for the individual workers, of the actions being taken by such umbrella companies.

Given the impermanent nature of employments of this kind, these individuals will normally be required to secure their engagement through an agency. For an agency worker, the agency or its intermediary is normally responsible for payment of the remuneration earned after first deducting tax and NICs under PAYE.

So-called umbrella companies, interposed between the agency and the individual, can play a useful role in those cases in which an individual may expect to enter into multiple successive engagements and wants to offload responsibility for the paperwork and tax compliance associated with such multiple engagements. However, some umbrella companies are promoting their services on the basis of being able to secure that the individual receives a higher amount of net earnings by structuring payments to the individual as if part only is a payment of remuneration, subject to PAYE, the balance being paid as either an “investment payment” (i.e. the umbrella company supposedly making an investment in the individual) or an “advance on a future bonus” and (so it is claimed) therefore being free of tax.

As the programme made clear, this is a form of abusive tax avoidance. Agency workers are deemed to be employees of the agency (s44 ITEPA 2003) and are liable to tax and NICs under PAYE on the whole of the  remuneration they earn including “every form of payment, profit or benefit” (s47). It is not sufficient, to avoid tax, simply to describe payments of remuneration as something else. To do so poses serious financial risk for both the individual worker and the agency involved. If the intermediate umbrella company fails to deduct and account for tax and employee’s NICs when making such payments, HMRC will look to recover the tax, with penalties and interest, initially from the agency (as the intermediary payee is invariably offshore) or, if it remains unpaid within 30 days of a Reg 80 determination being made on the agency, from the individual on the basis that it is a payment of ‘disguised remuneration’ (the umbrella company being a ‘relevant third person’).

It was said, by the so-called brokers marketing the services of such umbrella companies, that the arrangements made had been confirmed by counsel to be legal. If that is correct, such opinions are simply wrong or (as has been found to be the case in the past) do not in fact state what they are purported to assert.

It goes without saying that individuals and agencies should avoid entering into such arrangements. When what is offered seems too good to be true, it probably is. In this case, it most certainly is.

The programme later suggested that the actions of such umbrella companies were analogous to the arrangements formerly widely used to structure remuneration in the form of loans from a trust which were not expected to be repaid. The government eventually responded to those arrangements with the 2019 ‘Loan Charge’ which has enraged campaigners as it has had a serious financial effect upon those workers who were either lured into or obliged to enter into such arrangements. However, the present actions of certain umbrella companies, in purportedly describing remuneration paid to a worker as something it is not, is very different. This is simply ‘calling black, white’. If done with the intention of cheating the Revenue, this could have serious consequences for those involved.

Perhaps the real issue here is whether HMRC has sufficient powers and resources to penalise, where appropriate, those who devise and promote or market such abusive tax avoidance arrangements, particularly if they are operating outside the UK.

HMRC does have powers to impose sanctions and civil penalties, both (i) for failure to disclose tax avoidance schemes under the DoTAS regime and, under legislation made in 2014 and 2017, (ii) if persons persist in the promotion of schemes after earlier schemes have been defeated, or they have enabled tax avoidance by devising, marketing or facilitating a tax avoidance arrangement. Under the ‘penalties for enablers’ rules, anyone who designs, markets, or otherwise enables tax avoidance may incur a penalty equal to the fees it has generated from the arrangement.

The problem is that, if the promoter is an offshore company, it can easily be liquidated and the individuals behind it can, all too easily, escape such sanctions.

If HMRC can identify the individuals concerned and adduce sufficient evidence of wrongdoing, they might seek to bring criminal charges for, say, conspiracy to cheat the public revenue. However, the threshold needed to secure a conviction is high, and this can prove challenging. If the individuals concerned are in countries with which the UK does not have agreements for reciprocal enforcement of criminal sanctions, such efforts may be fruitless. HMRC announced earlier this year that criminal charges had been brought against a number of individuals in the UK, although it was unclear as to what forms of evasion these arrests related. The alleged offences included “conspiracy to cheat the public revenue”, “conspiracy to evade income tax and NICs”, “fraud by abuse of position” and “conspiracy to transfer, disguise or convert criminal property”.

The question is: does HMRC have the necessary resources to root out promoters where offences have been committed?

[1] First broadcast on Saturday 6^th June at 12:04 p.m and currently available on the BBC Sounds app.

The government has announced that the changes to IR35 due to come into effect in relation to work done on or after 6^th April 2020 will, as part of the response to Covid-19, be put back until 6^th April 2021. The announcement is to be found here: https://www.gov.uk/government/news/off-payroll-working-rules-reforms-postponed-until-2021

As a member of the working party that put together the EMI scheme which was originally legislated for in Sched 24, FA 2000, I very much welcome the government’s announcement, as part of the Budget today (11th March 2020), that it intends to “review the EMI scheme to ensure it provides support for high-growth companies to recruit and retain the best talent so they can scale up effectively, and examine whether more companies should be able to access the scheme.”

Coupled with the consultation on changes to the tax treatment of ‘hedge funds’, there may now be an opportunity to persuade the government of the need to extend eligibility to employees of companies under the control of private equity. Hopefully the existing statutory limits and other eligibility requirements will be examined with a view to broadening the scope of what has proved to be a remarkably popular and successful scheme allowing companies to attract and retain the best talent at the early, high-risk, stage of their development.

That said, the announcement of an immediate restriction, to £1 million, of the lifetime allowance for Entrepreneurs’ Relief will come as a disappointment to those holding EMI share options over valuable shares in the most successful qualifying companies.