EMI share options – A (EU) ‘fly in the ointment’

At lunchtime on 4^th April 2018, HMRC made the announcement reproduced below as “Employment Related Securities Bulletin No.27”.

It is apparent from this that it would be sensible for companies and/or their shareholders to defer the grant of any EMI options scheduled to be granted after 6^th April 2018 until the government has secured fresh EU State Aid approval from Brussels. As yet, we know not when – or even if – this will be, although we do know that HM Treasury is confident that it will be forthcoming, and that this will be sooner rather than later.

If there is some compelling commercial reason why a company needs to grant employee share options after 6^th April 2018, and before fresh EU State Aid approval has been given, and such options would otherwise be expected to qualify as EMI share options, careful consideration needs to be given to the terms on which such options are granted so that, if necessary, it will be open to the parties to cancel and re-grant such options at a time when the new options will qualify for the tax reliefs associated with EMI share options.

If the government were to allow the tax reliefs for options purportedly granted as EMI options after 6^th April and before fresh approval is given, the government would be obliged, under EU treaty obligations, to recoup from employer companies the element of state aid accorded by such reliefs. In effect, such options will fall to be treated as non-tax advantaged share options.

The final reference to “before 6^th April” is an error on the part of HMRC and should read “before 7^th April”.

If you would like to discuss this matter further, please contact me by email.

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Companies and advisers concerned with the grant of EMI share options

EU State Aid approval for the EMI scheme, expires on 6 April 2018. The government has, since last year, been following the process of applying to the European Commission for fresh approval and we await the Commission’s final response. We won’t receive this before 6 April 2018 and so those involved in the establishment of EMI schemes and grant of EMI share options need to be aware that there will be a period between the lapse of the existing approval on 6 April and a decision by the EU Commission on a fresh approval. The government is working hard to ensure this period is as short as possible.

HMRC considers that the State Aid approval applies to the granting of share options and therefore that share options granted up to and including 6 April 2018 won’t be affected by this lapse of the approval.

EMI share options granted in the period from 7 April 2018 until EU State Aid approval is received may not be eligible for the tax advantages presently afforded to option holders, and accordingly share options granted in that period as EMI share options may necessarily fall to be treated as non-tax advantaged employment-related securities options.

Companies may wish to consider delaying the grant of employee share options intended to qualify as EMI share options until fresh EU State Aid approval has been given.

HMRC will continue to apply its current guidance and practice, in relation to employment-related securities options validly granted as EMI share options before 6 April.

A further update will be provided in due course.

[End of announcement]

Share Incentives in Companies under the Control of Private Equity: Some Blue-Sky Thinking?

Employees of companies under the control of another body corporate – in particular, those controlled by ‘private equity’ funds – are excluded from participating in EMI share option and other tax-favoured employee share plans (SIPs, SAYE schemes and CSOPs). Given the substantial increase in the number of such employees in the UK now that so many British companies have fallen into the partial or entire ownership of such funds, it is suggested that the Government examine how such companies may allow their employees to share in the growth in value to which they contribute through share ownership in a manner which does not put them at a fiscal disadvantage compared with non-employee investors.

It is understood that, if the Government were to afford such a mechanism enabling such employees to participate in a type of share plan which is both relatively straightforward to establish and (crucially) has certainty as to the tax treatment for both employer and employees, members of the BVCA (for example) would be keen to direct or encourage investee companies to establish such plans, given that providing effective incentives to employees is just as much in the interests of the private equity fund as it is in the financial interests of the employees.

The idea of employees benefitting from being joint owners of shares in a company, under a ‘joint share ownership plan’ (or JSOP), was first developed in 2001 and has since been widely adopted by independent companies for allowing selected senior employees to benefit in excess of the limits under tax-favoured plans. The tax treatment of JSOPs has long been settled and accepted by HMRC. A JSOP has the benefit of allowing participants to benefit from growth in value of a share without the need for them to first acquire, and later sell, ownership of the whole of the share. However, at present a company has no certainty as to what is the taxable value of an interest acquired by an employee as joint owner, and the financial risks of discovering some time later that HMRC disagrees with the original estimate of the taxable value of an interest as joint owner of shares is perceived by private equity funds as commercially unacceptable. Leaving all consideration of tax aside, and all other things being equal, the JSOP is, or would be, the mechanism most favoured by private equity funds (when compared with non-tax-favoured share options, ‘growth shares’ or ‘phantom’ share schemes’).

Accordingly, it is suggested that HM Treasury consider consulting upon (with a view to including in the Finance Act 2019) provisions which will allow and encourage wider use of JSOPs in private equity-owned companies, but with strict rules on valuation and subject to a minimum proportion of the issued share capital of the company being made available to all employees through the plan over a given (10-year?) period.

Outline of the proposed ‘employees’ share scheme’

The idea is that, if a company commits to putting a prescribed minimum proportion of its issued ordinary share capital into joint ownership with all its employees (on an individual and ‘same-terms’ basis, subject only to a qualifying period of employment for eligibility), on terms whereby each participant will, for (at least) so long as he or she remains with the company (or group), benefit from all future growth in the ‘pro rata’ value of the jointly-owned shares (i.e. the growth to which they contribute as employees):

(a) the taxable value of such ‘interests in employment-related securities’ acquired by each employee would be treated as their intrinsic value (nil); and

(b) the company could then likewise permit selected employees to acquire such interests in additional numbers of shares of the same class (within a limit) on the basis of the same taxable value (nil).

It is suggested that such limit, on the number of additional shares in which interests as joint owner may be acquired on a selective basis, be a maximum of [8] times the number of shares in which every qualifying employee will acquire an interest as joint owner on that occasion.

To qualify for such favourable treatment:

(i) the shares used must be ordinary shares of the class which is both:

– that which is otherwise owned by the controlling shareholders; and

– the largest class (in terms of nominal value) in issue;

(ii) the ‘pro rata’ value of shares of that class would be determined by taking the ‘market value’ of the whole of the issued share capital of that class (as agreed with HMRC SAV), and dividing it by the number of shares in issue;

(iii) the threshold level, above which participants will be entitled to any increase in value, may be set at or above that pro rata value at the date of acquisition by employees of their interests as joint owners.

The co-owner of the shares would (typically) be the controlling company, but may instead be a trust established for the purpose.

Such an arrangement would:

allow all eligible employees to participate in the growth in capital value to which they contribute as employees;
require only minimal changes to current tax rules (with which it is entirely consistent) so as to provide that, if all conditions are satisfied, the initial taxable value of such an interest is deemed to be nil;
allow employees to participate as actual (joint) shareholders (as opposed to being mere optionholders), and therefore participate in (a pro rata share of) any dividends, and, if the joint ownership agreement so provides, the exercise of voting rights;

[An enhancement might be that, if the whole amount of any dividends on jointly-owned shares are paid to the employee joint owners, all such income would be treated as dividend income of the employee, not as ‘earnings’.]

– (provided the initial market values of the shares is properly identified and agreed at the outset with HMRC SAV) present little or no scope for abuse or ‘tax avoidance’.

Aside from tax, the concept of such ‘joint ownership’ avoids the situation (as under a ‘qualifying Schedule 2 Share Incentive Plan’) in which the company first ‘gives away’ the current accrued value of the shares, only to have to repurchase, or fund the repurchase (through a trust) of that same value when an employee leaves or wishes to sell. Under a JSOP, the employee only ever acquires an entitlement to future growth in value.

If, on the conditional basis proposed, the initial taxable value of the interests is accepted as nil, the only issue to be settled with HMRC SAV is, in the case of unquoted companies, the initial market value of the whole of the shares of that class in issue immediately after any new issue for the purposes of an award under the plan.

If agreed that the IMV of the jointly-owned shares is to be taken to be their pro rata value (i.e. market value determined on a pro rata basis with no discounts for minority interest, lack of marketability etc.), the legislation might also provide that:

– if a participating employee (or ex-employee) realises the value of his interest for a consideration calculated on the basis that the market value of the jointly owned shares is likewise determined on a ‘pro rata’ basis, there would be no charge to income tax on such disposal under Chapter 3D, Part 7, ITEPA (disposal of employment-related securities for more than market value); and

– if the shares are bought back by the issuing company, such a ‘purchase of own shares’ would be treated as a capital transaction and not give rise to a distribution income tax charge (as it would if the interest had been held for less than 5 years).

Practical experience of such ‘joint ownership plans’ since 2001 has been very positive, albeit with the difficulties of determining the initial taxable values of the interests (as joint owners) acquired by employees – exacerbated by the withdrawal by HMRC SAV earlier this year of any facility to agree such values for PAYE and self-assessment purposes.

Encouraging companies to establish such plans by removing that obstacle (identifying the taxable initial value of the employee’s interest) by requiring participation to be extended on an ‘all-employee’ basis would, we believe, prove to be of real attraction to a range of unquoted companies which extends beyond those which presently offer, or could offer, employee share participation.

Crucially, it is estimated that the cost to HM Treasury of facilitating such plans would be de minimis.

Disguised remuneration: EBTs and the new “outstanding loan” charge applying in April 2019 – what if the individual dies in the meantime?

The standard of legislative drafting in the UK is very high and particularly so in the case of tax legislation. It was therefore a surprise (and, I am afraid to admit, a matter of some satisfaction) to have discovered an error in the highly complex ‘disguised remuneration’ rules first enacted in 2010, and since amended on many occasions, most recently in the F(No.2)A 2017 to take account of the forthcoming “outstanding loans” charge in April 2019, and which the Parliamentary draftsman has accepted will need to be corrected in a future Finance Act.

The subsection in question is s554A(4) ITEPA 2003. As most recently amended, this is intended to provide that the 2019 “outstanding loan” charge will not apply if the individual who has received the loan from an EBT (or other relevant third party) has then died. It appears that the draftsman (perhaps understandably) overlooked the fact that the sub-section had already been amended by the first Finance Act of 2017. As a result, the words: “…or a relevant step within para 1 of Sched 11 to F(No.2)A 2017 which is treated as being taken…”[i.e. the 2019 outstanding loan charge] have ended up in the wrong place. As it stands, s554A(4) can be of no effect, as neither of the conditions in sub-paras (a) or (b) [i.e. that the relevant step is within s554B or 554C] will ever be satisfied in the case of such an ‘outstanding loan charge’.

To give effect to the presumed intention, s554(4) should read :

“Chapter 4 does not apply by reason of a relevant step taken on or after A’s death if:

(a) the relevant step is within s554B, or

(b) the relevant step is within s554C by virtue of subsection (1)(ab) of that section, or

(c) it is a relevant step within para 1 of Sched 11 to F(No.2) A 2017.”

The new HMRC Trust Registration Service: an HMRC clarification

This post follows on from that describing the new HMRC Trust Registration Service (“TRS”) below posted in 2017.

HMRC have confirmed, in an email exchange with me, that, in effect, a liability to stamp duty is a liability to a ‘relevant UK tax’ and therefore a trust which has only incurred a liability to UK stamp duty, and no other UK relevant tax, is still obliged to be registered. This may affect trusts holding unquoted shares.

HMRC have stated that their position is “that a trustee of a relevant trust that incurs stamp duty in relation to trust assets in a given tax year [is] required to register that trust on the TRS because the payment of stamp duty will cancel a SDRT charge that may otherwise arise. The TRS Regulations exclude a reference to stamp duty because an agreement for the purchase of shares normally gives rise to an immediate liability to SDRT and the SDRT liability is in turn cancelled by the payment of stamp duty. [HMRC] will ensure that in the next iteration of [their] FAQ guidance [they] will make this position clear”.

It had been widely understood that both the omission of an express reference to stamp duty in the Regulations, and the passage in HMRC’s original guidance, to the effect that a trust would not be regarded as having a liability to a UK relevant tax if there was a particular exemption or relief applicable, meant that trusts which had only incurred a liability to stamp duty, not SDRT, would have no immediate obligation to register. It is now clear that this is not intended to be the case.

More on Autumn 2017 Budget announcements

Other ‘small print’ items of interest to those involved with DR/EBT settlements are:

Extending offshore time limits – Assessment time limits for non-deliberate offshore tax non-compliance will be extended so that HMRC can always assess at least 12 years of back taxes without needing to establish deliberate non-compliance, following a consultation in spring 2018; and
the government will also legislate in ‘Finance Bill 2017-18’ to put beyond doubt, with effect from 22 November 2017, that Part 7A of Income Tax (Earnings and Pensions) Act 2003 applies regardless of whether contributions to disguised remuneration avoidance schemes should previously have been taxed as employment income [per the Rangers’ decision] – this change will have effect on and after 22 November 2017.

SAYE share option schemes: Autumn 2017 Budget change

The Chancellor has announced a small change to the terms of SAYE savings contracts linked to savings-related share options.

Employees on maternity and parental leave will, from 6 April 2018, be able to take up to a 12 month pause from saving into their SAYE savings contracts. The current time limit for taking such a ‘savings holiday’ is 6 months.

HMRC’s new Trust Registration Service – trustees’ obligation to register

To give effect to its obligations under The Money Laundering, Terrorist Financing and Transfer of Funds (Information on The Payer) Regulations 2017 (“the MLTFTF Regs.”) – which give effect to the 4^th EU Money Laundering Directive – HMRC has established an online Trust Registration Service (“TRS”). In consequence, the old HMRC Form 41G providing limited information about a trust for tax purposes has been withdrawn. Existing trusts which have submitted a Form 41G must register under the new online service.

It should be noted that the scope of the TRS extends beyond that of HMRC’s own obligations under Reg 45 of the MLTFTF Regs, which apply only to a trust or company service provider acting in the course of a business in the UK, in that the TRS applies to anyone acting as a trustee of an express trust which incurs a liability to a relevant UK tax.

The TRS may be accessed through:

www.gov.uk/government/publications/trusts-and-estates-details-41g-trust

Trusts not already registered with HMRC for self-assessment and which have incurred a liability to UK income tax or CGT in a tax year must register by 5 October after that tax year or, if first liable for another relevant UK tax in a tax year, 31 January after the end of that tax year. (No penalty is imposed if, in relation to the tax year 2016-17, the registration of a trust not already registered for self-assessment and which has incurred a liability to income tax or CGT for the first time, is completed before 5 December 2017.)

HMRC published detailed guidance on the new TRS on 9 October 2017.

Registration is not required in a given tax year if:

– the trustees do not need to file a tax return and have not incurred a liability to a relevant UK tax;

– the trust is a non-UK express trust and has no UK source income or UK based assets but for some other reason has incurred a liability to pay any of the relevant UK taxes; or

– the settlor or a beneficiary has incurred a liability to pay a relevant UK tax but the trustees are not so liable; or

– the trustees are holding the trust property as bare trustees (as any liability to a relevant UK tax is that of the beneficiary).

It would seem to follow that trustees of a non-UK resident employees’ trust which is not liable to a relevant UK tax is not obliged to register, but the trustees may wish to do so voluntarily to avoid unintentionally failing to do so if such a liability should arise. Changes to the information registered may be notified at any time and, if the trustees incur a liability to a relevant UK tax in any tax year, must be so notified by 31 January next following. Curiously, details of the trust assets need only be provided once at the point of first registration and are not required by HMRC to be updated. Information on assets later added or held is to be provided in the annual trust tax return (SA900). In the case of multiple trustees, a lead trustee may be nominated to be responsible for the administrative duties in relation to the tax affairs of the trust and will be the main point of contact for HMRC. Trustees may appoint an agent to register on their behalf, but the legal responsibility remains that of the trustees.

Changes in the information provided must be notified by 31 January next following the tax year in which the change occurred if in that year the trustees were liable to a relevant UK tax. If they are not so liable, the obligation to update is deferred until 31 January after the next tax year in which they are so liable, although trustees may, and in practice are expected to, update on a voluntary basis even if not so liable. So, for example, if trustees of an employees’ trust make share awards to employees in circumstances in which the trustees are not themselves liable for any relevant UK tax, there is no obligation to notify a change of beneficial ownership, although the trustees have a duty to maintain a written record of the awards. If a beneficial interest in unquoted company shares is sold, triggering a liability to SDRT, this will normally be a liability of the transferee, not of the trustees. The trustees must register if, exceptionally, a liability to CGT arises on their part because the shares are sold otherwise than pursuant to an option and in circumstances not qualifying for a claim to be made for hold-over relief from CGT (which might be the case if the company has non-business assets or a liability to inheritance tax arises on the part of the trustees under s72 or s65 IhTA 1984).

Information which, because of shortcomings in the software, cannot be notified (such as, for example, details of more than one corporate trustee) may be provided in writing to: Trusts, HMRC, BX9 1EL.

To avoid liabilities to income tax under the ‘disguised remuneration’ rules, it is common practice for trustees of an employees’ trust to agree with the employer company that they will satisfy awards or option exercises by transferring shares without having the names of the employees disclosed to the trustees. In such a case, it is difficult to see how the trustees can provide information on the employees or ex-employees concerned until they have been given the names, typically when the awards become vested or the options exercised. That is clearly the occasion of a change in the information provided, but an obligation to notify HMRC of the change will not immediately arise if the trustees are not in that tax year liable to a relevant UK tax. That said, it is likely to be easier in practice for the trustees to update the information on a voluntary basis regardless of whether such a liability has arisen. If thereafter the trustees hold the bare legal title to the shares on behalf of the employee or ex-employee, it would seem that no further obligation to notify any change in the information provided to HMRC would arise by reason only of the beneficial owner deciding (for example) to sell the shares, as a liability to a relevant UK tax would not then arise at the trust level.

Employees’ trusts

The HMRC guidance refers to “employee ownership trusts”, but this is understood to be intended to refer to all forms of employees’ trusts and not merely those which rank as “employee-ownership trusts” (per s236H TCGA 1992). In such cases, the guidance provides that “to help keep administrative burdens to a minimum for business type trusts with large numbers of beneficiaries…the trustees will only be asked to identify the class of beneficiary if the number of named beneficiaries exceed 10”. It appears to follow that, if in the case of a typical ‘s86-type’ employees’ trust, there are fewer than 10 employees, or there are named beneficiaries but fewer than 10 of them, details of those beneficiaries must be given. Likewise, details must be given of any beneficiaries who are in receipt of benefit and can be named, regardless of how many there are of such actual beneficiaries. The guidance goes on to provide that the identity of current “key employees and Directors” must in any event be provided.

Meaning of “key employees and Directors”

This is defined in the HMRC guidance as “staff who are responsible for the operational running of the business at the top of the organisational chain by making key decisions or that have a financial ownership or stake in the organisation. We [HMRC] would also define this as key members of staff whose skill and expertise are critical to the business for which they enjoy a high level of remuneration….”

Share Incentive Plan trusts

As these are express UK trusts, the trustees are obliged by Reg 44(1) to maintain written records of the beneficial owners (as defined) and potential beneficiaries. The obligation to register the trust with HMRC, and notify the appropriate information and any changes to it, arises only if and when the SIP trustees have a liability to a relevant UK tax in a tax year. It should be noted that dividends on unawarded shares are now charged to income tax at the dividend ordinary rate (the exemption for dividends on such shares in the “applicable period” now extending only to tax at the higher dividend trust rate). If the shares are purchased in a transaction attracting a charge to SDRT or if unawarded shares are sold outside of the “relevant period” so as to attract a CGT charge, an obligation to register will arise. In practice, therefore, SIP trustees are likely to want to register voluntarily to avoid inadvertent failure to register when obligated to do so.

Details of the trust assets

Details to be given include the nature of the trust assets and the value of shares (or other assets) held based on their market value at the date the information is first provided. A formal share valuation is not required, although “[HMRC] would expect trustees acting within their professional duties to provide a good estimate of the market value of the assets” and reference is made to HMRC’s Shares and Assets Valuation Manual. If the trust was established long ago and the value was previously notified through either Form 41G or the SA return, “you should just complete “Other asset” field using the term – “Already notified”, leaving all other asset fields marked as “£1”.”

Details of advisers

The TRS requires only the details of any agent acting on behalf of the trustees in relation to their registration and not of other advisers. The information about an agent is their name, address, telephone number and customer/agent reference. The trustees, if acting in the course of business carried on by them in the UK, do however have an obligation under the MLTFTF Regs to keep written records of the full name and address of any paid advisers providing legal, financial or tax advice in relation to the trust.

The data provided to HMRC

The information given to HMRC is not on the public record and, if requested, can only be shared by HMRC with law enforcement agencies in the UK or an EEA member state.

‘In-house’ trust companies

It is not uncommon for a private company to establish a wholly-owned subsidiary to act as sole corporate trustee of its employees’ trust and/or its qualifying Share Incentive Plan. Such a trustee company would be acting in the course of business, even if it receives no consideration for acting as trustee and will be obliged to maintain written records and register the trust with HMRC pursuant to the TRS.

Fresh thinking…a new share incentive scheme for employees of PE-backed companies?

A company under the control of another company cannot grant EMI share options and, unless it is under the control of either an employee-ownership trust or a fully-listed company, cannot establish a tax-favoured Share Incentive Plan or SAYE share option scheme. Given that (according to the BVCA) an estimated 515,000+ individuals are employed by UK companies owned by private equity and venture capital funds (which invariably hold their interests through a corporate vehicle), this excludes a substantial proportion of the workforce from participation in such plans.

Whilst members of the BVCA are keen to provide employee share incentives in investee companies, they are presently faced with having to incur significant fees to establish bespoke plans with uncertainty as to the quantum of any liabilities to tax and NICs on share awards. They seek a ‘well-trodden path’ which, if followed by investee companies, will allow employees to benefit from future growth in value on a similar basis to that of other investors.

HM Treasury is alive to the difficulties experienced by PE and VC fund managers in implementing a simple, easily-understood, and cost-effective employee share scheme in a manner which affords both capital treatment for employees in relation to future gains and security for the employer against HMRC enquiry or compliance challenge. One solution would be to allow a trading company controlled by a “PE vehicle” – if such a term were exhaustively defined – to grant EMI share options and establish a SIP or SAYE share option scheme. However, there are obvious difficulties in identifying and then defining the types of PE and VC funds and their investee companies which should enjoy such privileges.

Earlier this year, representatives of the BVCA and the ESOP Centre met with officials at HMT to propose a solution to this conundrum which I have been developing with those bodies. The idea builds upon the concept of ‘joint share ownership’ first developed in 2001, which has since been widely implemented by British companies. The tax treatment of that concept has long been settled with HMRC.

In brief, the proposal is as follows:

A trading company (or holding company of a trading group) under the control of another body corporate (and not otherwise eligible to make awards under a qualifying SIP) may from time to time invite all employees having a qualifying period of employment to accept the award of interests as beneficial joint owners of a given number of ordinary shares in the company, being shares of the largest class in issue and of the largest class held, or ultimately owned, by the PE or VC fund. Such an interest would entitle the employee participant to growth in value of the jointly-owned shares above a threshold level which is not lower than the pro rata value of such shares at the time of award. Crucially, HMRC SAV should – it is suggested – be willing to agree the value of an investee company for these purposes. Provided that such interests are awarded on an ‘equal terms’ basis (broadly as per Share Incentive Plan participation), and subject to a limit on individual participation, the initial taxable value of an employee’s interest would be taken to be zero. (Given that no discount for minority interest, etc., would be applied, the value of such an interest would otherwise have been determined as a ‘premium-priced option’ and therefore it is suggested that any loss to HM Treasury of ‘up-front’ tax would be relatively modest – if any.) A deemed s431 tax election would then ensure that, in the absence of any tax avoidance feature, gains realised upon the disposal of such interests would fall to be taxed as capital gain (and, if the Government were particularly generous, might qualify for the reduced 10% rate of CGT by way of Entrepreneurs’ Relief, as in the case of certain disposals of EMI option shares).
By way of an inducement to qualifying companies to establish such a plan, such certainty of tax treatment might also be extended to similar awards made on a selective basis to key employees over greater numbers of such shares, provided that such number of jointly-owned shares does not exceed a specified multiple (of, say, 8 times) of the number of shares in respect of which awards are made to all eligible employees on the same occasion.

The perceived attractions of such a plan include:

its relative simplicity to establish and document: the co-owner could, for example, be the holding company of the company whose shares are used, and the relationship with participants would be governed by contract. The co-owner could easily repurchase interests from participants who leave at a price determined on a ‘good/bad leaver’ basis;
the fact that, unlike a SIP, a participant benefits only from future growth in value of the jointly-owned shares and, unlike a ‘market value’ share option, the employee is not put to the expense of funding the acquisition of the shares, only for the shareholders then to be burdened with the cost of funding the repurchase of shares from ‘good leavers’ – rather, it is only the growth in value to which the participant ever becomes entitled;
the fact that only if and insofar as there is growth in value will benefit accrue to both employees and, to the extent that a charge to CGT arises, to HM Treasury – most existing forms of ‘growth share’ plans or JSOP arrangements involve an initial charge to tax at a time when any real growth in value has yet to accrue;
setting the threshold level (above which the participant benefits from growth in value) at the ‘pro rata’ value of an ordinary share, and acceptance that the initial unrestricted market value of such an interest is nil, would avoid the complex and expensive process of estimating the value of a ‘growth interest’; the valuation exercise would normally be confined to a valuation of the whole of the issued share capital or of the class of share used.

It should be emphasised that this is merely a proposal made to HM Treasury officials who are understood to be ‘kicking the tyres’. It is not claimed to be a panacea, and others may come up with better solutions, but it does address the concerns of private equity and VC-backed companies excluded from existing tax-favoured government sponsored share plans and has the support of the BVCA. Thus far, no fundamental objection or technical obstacle has been raised, although as it will require primary legislation, we should not perhaps hold our breath…

Selling a company, tax-free, to an employee ownership trust (“EOT”)

Since 2014, if all statutory conditions are satisfied, disposals of shares to an EOT, amounting to at least a 51% controlling interest in a trading company, willattract complete exemption from capital gains tax. On the face of it, this affords an extremely attractive means of allowing private company proprietors, and particularly owner-managers, to pass on ownership to a trust for employees controlled by (i.e. the power to appoint and remove trustees is vested in) the directors of the EOT-owned company and for the purchase to be paid for out of the company’s own profits and/or borrowing facilities. Furthermore, a company owned by an EOT may pay tax-free bonuses, of up to £3,600 per tax year, to all qualifying employees on an ‘equal terms basis’ – a significant benefit to smaller companies.

It is understood that some 80+ companies have so far each been sold to an EOT, although the majority of these are believed to be relatively small in value (and many of which were formerly run as quasi-partnerships distributing profits in full each year).

A description and commentary on the statutory rules governing EOTs is to be found in Chapter 24 of “Employee Share Schemes” (Thomson Reuters).

Having now advised on a significant number of actual and potential ‘sales to an EOT’, the following points, born of practical experience, may be of interest and assistance to those proprietors and their advisers contemplating such a transaction:

An EOT is necessarily restricted in how it can benefit employee beneficiaries if penal tax charges are not to be triggered on the part of the trustees. In short, any disposition of trust property must be on an ‘equal terms’ basis and only to those who are current employees. A subsequent sale of the company by the trustees will trigger a clawback charge. It might be worth pausing to consider if, rather than selling tax-free for, say, 100, a sale at a higher price of, say, 111 to a more conventional discretionary employees’ share trust might be justified, the vendor(s) presumably qualifying for the reduced 10% (entrepreneurs’ relief) rate of CGT and therefore being in no worse position. The trustees might be justified in agreeing to pay such a higher price (always provided it does not exceed the market value of the company) given the freedoms they would then enjoy to on-sell the company or pass a controlling interest into the hands of management by the grant and exercise of EMI share options and participation in a SIP and/or SAYE share option scheme.
In most of the cases on which I have advised, the sale has been ‘vendor-financed’. In other words, the company has insufficient funds available to pay the agreed consideration in full up-front. The question arises as to how best to protect the interests of the vendor(s) , and ensure that the company does in fact make further cash contributions to the trust, without triggering charges to tax on the part of the trustees or prejudicing the tax relief afforded to the vendor(s)? There is no reason why a vendor cannot remain on the board of the company and/or hold office as a trustee, although care is needed in addressing the obvious conflicts of interest which then arise. In practice, a more effective protection may be afforded by having the company first issue to the vendor a redeemable ‘golden share’ which carries negative control rights, and entrench those rights in the articles (i.e. making it impossible, once the sale has been completed, for the controlling trustee shareholder to abrogate the rights of the vendor as holder of the golden share until the consideration is fully funded and paid by the trustees and the share redeemed for a nominal amount). The negative control rights of the golden shareholder provide, in effect, that until the consideration is paid in full, the company is restricted in how it may apply its profits save for making contributions to the trust.
Vendors should bear in mind that, if the company cannot fund the consideration in full up-front, the vendors cannot take security for payment of the balance in the form of a charge over either the shares held by the trust or (although on the wording of the legislation this is not beyond doubt) the assets of the company. Remember also that, whilst the shares will have qualified for Business Property Relief from inheritance tax, the rights as unsecured creditors acquired in exchange will not – a matter which will be of concern to older vendors in particular.
Legal costs of the documentation and the sale are rightly of concern, especially in the case of smaller companies, the value of which will not justify substantial fees. To address this, I have developed a set of ‘standard-form’ documentation comprising the EOT trust deed, trust company articles, company governance and additions to Table A articles as well as the SPA documentation, all intended for use in the case of straightforward vendor-funded sales to an EOT. Accountants and other advisers interested in making use of such pro-forma documentation should contact me for further details and costings.
It has been suggested that the penal clawback charge (which falls on the trustees) arising if, for example, the trust ceases to own a controlling interest, might be avoided if the trustee is an independent offshore trustee services company so that the trust is outside the scope of the charge to UK capital gains tax. This is permitted under the legislation (although, following publication of the ‘Paradise Papers’, it may attract opprobrium….) which was prevented, by EU freedom of movement of capital rules, from stipulating that the trustees must all be UK resident. However, the use of any independent trustee – whether or not it is UK resident – rather than either a specially-formed wholly-owned subsidiary of the company being sold or individual trustees a majority of whom are long-standing directors and/or employees of the company, gives rise to a number of difficulties and, in practice, offshore trustee service providers have shown an understandable reluctance to accept office as sole corporate trustee of an EOT (although, to my knowledge, there are a number of such overseas-controlled EOTs in existence including, for example, that which now owns The Adam Smith Institute and was the subject of reports in The Sunday Times early in 2017). Not least is the duty of trustees to understand what it is they are investing in. The duties of an independent trustee company holding a relatively small proportion of the issued share capital for the purposes of giving effect to employee incentive plans are very different from those of a trustee being recommended to acquire a controlling interest in a company. The latter needs to undertake full due diligence and seek appropriate warranties and indemnities from the vendor(s) so as to ensure that the price being paid, and the funding obligations, do not leave the trustee exposed to liability if their acquisition proves to be a ‘pig in a poke’. Going forward, it is insufficient for controlling trustees to rely upon information from the directors of the company without troubling themselves to make appropriate enquiries and take an active role in overseeing the management of the company, as would any other controlling shareholders of a trading company.

To be continued…..