Employee – ownership trusts and tax free bonuses
Two valuable tax reliefs encourage indirect employee share ownership along the lines of the model used by the John Lewis Partnership.
In outline, this involves employees being beneficiaries of a discretionary trust (the Employee – Ownership Trust or EOT) which owns the company or group of companies by which the beneficiaries are employed.
For a trust to qualify as an EOT a number of conditions have to be satisfied including the requirements that:
- The company owned by the trust must be a trading company or the parent company of a trading group.
- The trust must operate for the benefit of all employees (other than certain excluded “participators”).
- The trust must have a controlling interest in the employing company or group of companies.
A key issue faced by founder shareholders who want to encourage employee share ownership is the tax consequences. Whilst there are reliefs which enable the transfer of shares in a trading company (or the holding company of a trading group) to be made without incurring a liability to capital gains tax, the amount which the Founders can receive for the transfer is limited.
However, on a qualifying sale to an EOT they can receive proceeds up to the market value of the shares without giving rise to a tax charge. This is a very valuable relief.
To further encourage the creation of EOTs, bonus payments can be made to employees which, up to £3,600 per annum, are free of income tax (but not national insurance contributions). As always a number of conditions have to be satisfied, including the requirement that all employees participate on equal terms.
Tax was somewhat simpler when John Spedan Lewis gifted the shares in his department stores but the reliefs available for Employee-Ownership Trusts help reduce the obstacles to emulating him.