Consultation outcome

new employee shareholding vehicle

Updated 10 December 2014

This was published under the 2010 to 2015 Conservative and Liberal Democrat coalition government

1. Introduction

The government is committed to supporting employee ownership and encouraging its use more widely in UK business. The independent Nuttall Review of Employee Ownership in 2012 concluded that companies with employee ownership produce a number of economic benefits, including resilience during the economic downturn, faster job creation, and higher levels of commitment amongst staff.

The government has introduced a number of important tax changes to support employee ownership and the Office of Tax Simplification’s (OTS) work has been an important catalyst for improvements in the related area of employee share schemes. After its inception in 2010, the OTS’s early discussions with business found that employee share schemes are perceived to be a highly complex area of the tax code. This complexity is seen as a frequent cause of error in tax returns and as a source of administrative burdens on employers, their advisers and employees. As a result, the government commissioned the OTS to review share schemes and recommend simplification proposals to reduce unnecessary complexity and reduce administrative burdens for users.

The work undertaken by the OTS and its recommendations have enabled the government to undertake the most significant package of reform to the tax rules for employee share schemes for many years. The Finance Bill 2014 is legislating for five recommendations made in the OTS report on unapproved share schemes, as well as earlier recommendations for self-certification by companies of tax-advantaged employee share schemes; online filing of tax-advantaged employee share scheme forms; and more clarity around features that are not permitted within these schemes.

The government now wants to investigate the potential opportunity to go further in meeting the OTS’s recommendations. As outlined in the Exchequer Secretary to the Treasury’s recent letter to the Chairman and Tax Director of the OTS, the government wants to seek views from businesses, employees and share scheme experts on some of the important issues raised by the proposal for an “employee shareholding vehicle”. The OTS believes this proposal would allow shares in unquoted companies in particular to be held and traded on behalf of their employees more easily and at reduced cost without the perceived hurdles for existing employee benefit trusts (EBTs). This is a far-reaching idea and it is important that, before taking a decision on whether to proceed, the government has a firm understanding of the implications of introducing such a vehicle

1.1 Scope of the discussion paper

This discussion paper explores the case for change made by the OTS and the potential issues that the introduction of an employee shareholding vehicle raises. It aims to develop the understanding of the scope to introduce a simpler vehicle by seeking views on:

  • the level of demand for such a vehicle should it be introduced
  • the relative need and demand for the exemptions recommended by the OTS
  • the effectiveness of the safeguards for the Exchequer recommended by the OTS and whether further safeguards might be necessary to protect against tax avoidance

Responses to this paper will inform the government’s next steps. Consistent with the tax-policy making framework, should the government decide to proceed with the implementation of an employee shareholding vehicle then it is the intention that there would be a formal consultation to seek views on the detail.

The government is keen to hear views from companies that currently use unapproved employee ownership schemes and from those that have so far decided against doing so for reasons of complexity and cost. The views of advisers and employee share scheme experts will also be very important in aiding the government in reaching a decision on how to proceed.

When responding to the questions posed in this discussion paper, particularly in relation to the tax issues and safeguards explored, it would be helpful if consideration could be given to:

  • the extent to which the tax issue itself arises currently
  • any related administrative costs or burdens
  • what would change as a result of the proposals

1.2 Current landscape

Companies wishing to make arrangements to incentivise and reward employees through shares and other securities can do so in a number of ways. In summary these are:

  • shares/options provided to employees through tax-advantaged share schemes, such as the company share option plan (CSOP), enterprise management incentives (EMI), save as you earn (SAYE or Sharesave), or the share incentive plan (SIP)
  • shares provided to employees as part of their employee shareholder employment status
  • employee ownership, where employees hold or control a significant proportion of the share capital in a company and have a say in the running of that company. Shares can be held directly by employees, held indirectly by a trust, or a combination of the two
  • shares, share options, or other securities through other arrangements, including EBTs

1.3 The OTS case for change and proposal

As stated in the OTS’s report, the government recognises that EBTs are one of a range of employee share ownership models that may be legitimately applied without the intention of avoiding tax. However, the OTS has identified some complexities faced by companies and their advisers that can discourage the use of EBTs or result in them being established offshore.

The OTS advised the government that there is a case for providing companies, particularly unquoted companies, with access to a simpler and more cost effective vehicle that would allow them to hold, acquire and dispose of shares. This is primarily for those companies that wish to reduce administrative costs by switching from an existing vehicle or have been discouraged from employee ownership altogether because of the cost and complexity. The OTS proposal is not designed to provide companies with tax advantages beyond those that could currently be legitimately claimed by operating an existing EBT or offering shares through the market.

The OTS describes the central case for change in its final report as follows:

“Our third recommendation is the introduction of a simple vehicle to enable companies (mostly, but not exclusively unquoted) to manage their employee share arrangements and create a market for employees’ shares. This could be a statutory “safe harbour” employee benefit trust (EBT). However, EBTs have acquired something of a bad name of late because of their use for tax avoidance purposes and we have no wish to create new avoidance opportunities. There is, though, a real need to create a vehicle – some form of entity that might be a form of EBT – which can be used safely and easily by private companies wishing to establish employee share schemes. Companies need such a vehicle to provide a marketplace for employee shares and to allow such shares to be warehoused until allocated to individuals. Accordingly, we recommend an ‘Employee Shareholding Vehicle’; this may be a trust but in this report we use ‘vehicle’ so as not to prejudice reactions to this recommendation. The aim is to provide companies with protection from some of the tax traps which exist in the extremely complex anti-avoidance legislation but at the same time ensure protection for HMRC by restricting carefully what this vehicle can be used for. This recommendation is of particular importance if government policy is to encourage wider employee ownership in private companies.”

The OTS outlines a number of tax issues that the vehicle could address to achieve its aim of providing a simpler vehicle for those wishing to use an employee ownership scheme and create a marketplace for employees‘ shares. These issues are:

  • the risk of inheritance tax charges under certain circumstances unless certain rules are followed
  • the risk of charging capital gains tax on trustees’ gains and income tax on shares received by an employee encourages offshore EBTs, which are considered more costly to administer than onshore equivalents
  • tax on loans to finance EBTs
  • the transaction in securities rules
  • stamp duty reserve tax on the purchase of shares by the trustees of an EBT, or by employees when they purchase shares from the trustees
  • access to other tax-advantaged schemes under certain circumstances
  • the recently introduced arrangements to tackle the deferral or avoidance of income tax or national insurance contributions through disguised remuneration

To protect the Exchequer from potential abuse by the minority, the OTS also recommend a number of safeguards:

  • the vehicle should be a UK resident and, if a trust, all its trustees should be UK resident
  • beneficiaries should be limited to employees and former employees rather than the wider definition under the Companies Act 2006, which includes spouses, civil partners and minor children or step-children
  • property held within the vehicle must not be applied other than for the specific purpose of encouraging or facilitating employee shareholding
  • the new vehicle may deal only with fully paid non-redeemable ordinary shares in the sponsoring company or its holding company, except in the case of a corporate transaction in cash or resulting in a share for share exchange
  • that breach of any of these conditions would mean the exemptions would no longer apply and which could, potentially, be backdated for several years unless the breach is proven to be trivial or accidental

The rest of this discussion paper explores the issues raised by these recommendations.

2. Discussion of tax issues identified by the OTS and its recommendations

Following its discussions with business and experts, the OTS reports a number of tax issues for companies when they establish an EBT. These are summarised below, along with the OTS recommendations to address those issues through a vehicle aimed at those companies wishing to make arrangements purely for the purpose of genuine equity based rewards and remuneration for employees as opposed to the tax planning activity. In summary these issues are:

  • the risk of inheritance tax charges under certain circumstances unless certain rules are followed
  • the risk of charging capital gains tax on trustees’ gains and income tax on shares received by an employee encourages offshore EBTs, which are considered more costly to administer than onshore equivalents
  • tax on loans to finance EBTs
  • the transaction in securities rules
  • stamp duty reserve tax on the purchase of shares by the trustees of an EBT, or by employees when they purchase shares from the trustees;
  • access to other tax-advantaged schemes under certain circumstances
  • the recently introduced arrangements to tackle the deferral or avoidance of income tax or national insurance contributions through disguised remuneration

The OTS recommends that anything short of all (or most) of these points being addressed would not provide companies with a practicable proposition for wishing to use a new vehicle for employee shares.

Question 1: Which of the issues identified by the OTS create the greatest complexity and administrative cost for companies? Please give practical examples if possible, including any behaviour that specific examples encourage, such as establishing offshore EBTs.

The employee shareholding vehicle is intended to be a simple vehicle to enable companies (mostly, but not exclusively unquoted) to manage their employee share arrangements and create a market for employees’ shares. This section provides an initial analysis of the exemptions highlighted by the OTS, and the criteria that may be required in order to properly define the vehicle. For some exemptions and criteria further evidence is necessary for the government to be able to decide whether or not the proposed vehicle should include them.

These are all considered in detail below and views are invited on the government’s initial views.

Certain aspects of the inheritance tax regime including the charge on participators for transfers to an EBT by a close company (s94 Inheritance Tax Act 1984 (IHTA 1984)), the gift of a controlling interest, and the 10 year and exit charges

The OTS recommends that as the majority of EBTs put in place by specialist advisers are drafted specifically as “section 86 trusts”, so that these charges do not arise, then it should be “the default position for companies wishing to establish straight-forward, non-tax avoiding EBTs for the purpose of implementing employee share plans”. It recommends the new vehicle should therefore not be subject to certain aspects of the inheritance tax regime, including the charge on participators for transfers to an EBT by a close company (s94, IHTA 1984), charges on the transfer by an individual of a controlling interest in a company to an EBT, and the 10 year and exit charges, which would normally apply to relevant property trusts.

The OTS highlights that it is currently possible to design a trust so that it is legitimately exempt from the charges but that this often requires access to specialist advice. The government acknowledges that the current rules and guidance could be simplified in order to make it easier for companies to achieve the exemptions that are available, in line with s86 IHTA 1984, providing that this does not present opportunities for avoidance. In principle, the government considers it appropriate that a potential vehicle, suitably designed to ensure that the transfer of assets into the trust are for the benefit of employees only, could have certain existing exemptions applied to it in a simpler way than is currently the case for EBTs.

Question 2: What would be the effect of providing simpler access to existing inheritance tax exemptions through this vehicle?

Capital gains tax on the disposal of qualifying assets to an employee (removing the current risk of a double tax charge for onshore EBTs arising out of s239ZA of the Taxation of Chargeable Gains Act 1992 (TCGA 1992) which gives relief only in limited circumstances)

Any increase in the value of shares whilst held by the trust, will result in a gain that is subject to capital gains tax when they are transferred to an employee, but the employee may also be subject to an income tax charge based on the market value of the shares at the time they receive them. The OTS suggests that many companies operate EBTs offshore because relief under s239ZA TCGA 1992 for the capital gains tax payable on the disposal of qualifying assets to an employee is often not available to onshore trusts. The OTS therefore recommends that the new vehicle should provide simpler access to this relief, potentially via a relaxation of some of the conditions that give rise to a capital gains tax charge on the disposal of qualifying assets to employees. It suggests this could lead to the majority of legitimate offshore EBTs moving onshore, which would make them cheaper to run and easier to administer for companies.

The government recognises action could be taken to create a more level playing field between onshore and offshore trusts, removing a barrier to the establishment of onshore EBTs which could be easier and cheaper for companies to administer, and allow for stronger oversight as well.

Question 3: Which conditions of s239ZA TCGA are most onerous for onshore EBTs to meet, and why? What would be the effect of relaxing the conditions for capital gains tax relief under s239ZA to the new vehicle?

S455 Corporation Tax Act 2010 (CTA 2010) (loans by close companies to participators) should not apply if a company loans money to the vehicle in order to finance its activities

Companies sometimes loan money to an EBT to help finance its activities, such as helping the EBT to purchase shares. Loans by close companies to EBTs can result in tax charges under s455 CTA 2010, for example where the EBT holds shares in the company. This tax can be reclaimed when the loan is repaid (s458 CTA 2010). The OTS highlights that the s455 CTA 2010 charge potentially causes cash flow problems and there is no credit for the loan given in the company’s liability to corporation tax, which can be a disincentive to establish an EBT. The OTS recommends s455 should not apply if a company loans money to the vehicle in order to finance its activities.

S455 CTA 2010 has existed in much the same form since 1965, and was designed to ensure that company monies are not extracted by participators in a form that it not subject to income tax, i.e. in a form that is not remuneration or a dividend/distribution. The rules exist specifically to reduce the risk of avoidance and are deliberately wide-ranging. The government monitors activity in this area and has recently strengthened and extended the regime to prevent companies and their participators from side-stepping the provisions. The government has also considered the regime as a whole during its recent consultation on the reform of close company loans to participators rules. Although the government decided not to proceed with broad reform of those rules, HMRC continues to engage with interested parties on targeted adjustments to the regime, including loans to EBTs. This work is ongoing.

Other methods of financing activities of an EBT, such as bank loans or a company contribution to the EBT, would avoid a liability under s455 CTA 2010 while still achieving the aim of providing genuine liquidity to the vehicle. Furthermore, the tax under S455 CTA10 does not become due for up to 21 months after a loan has been made (if at all). The government also notes the concern raised by the OTS regarding whether s455 CTA 2010 would apply if a loan is made by a company when it is not close, but subsequently becomes close. This would only be the case in very specific circumstances, and experience suggests that it only occurs very rarely in any case.

The government considers the protection to the Exchequer afforded by s455 to be necessary to safeguard against abuse, though recognises the potential issues raised by the OTS. It does however remain open to views on including an exemption if a strong case can be made.

Question 4: What would be the effect of continuing to apply s455 CTA 2010 to any new vehicle? How often, given the considerations above, do circumstances arise where its application is an issue for companies?

Provided securities are not sold for more than market value they should fall outside the transactions in securities rules

The OTS recommends that provided securities are not sold for more than market value they should fall outside the transaction in securities rules.

The transactions in securities rules can only apply where there is a main purpose of obtaining an income tax advantage. An arrangement which does not have this purpose where there is a clear intention to provide an opportunity for employees to share company ownership through the vehicle is therefore already excluded from being caught by the rules. The valuation of the securities in themselves is not the main determinant of whether avoidance is the objective of the transaction although it would be a factor in considering whether the provisions should apply. Statutory provision is made for formal clearance where there is any doubt about the application of the rules.

While the government currently considers this exemption not to be strictly necessary for any new vehicle, it remains open to its inclusion if a strong case can be made. It is particularly interested in whether there are any alternative approaches that might address the issues identified by the OTS without providing an exemption from the rules, including if HMRC provided guidance outlining under what circumstances particular transactions would be usually be considered to be within the rules.

Question 5:What would be the effect of continuing to apply the transaction in securities rules to any new vehicle? Is there an alternative approach, such as guidance, that could address the issue identified by the OTS and provide companies with confidence about its use of the vehicle without providing an exemption from the rules?

Transfers of qualifying securities between the trading vehicle and the beneficiaries should be exempt from stamp duty/stamp duty reserve tax

The OTS suggests this is a disincentive and recommend that transfers of qualifying securities between the trading vehicle and the beneficiaries should be exempt from stamp duty reserve tax.

Currently, EBTs are subject to the normal stamp duty and stamp duty reserve tax rules, unless they happen to be a tax-advantaged scheme like a SIP. Share transactions involving EBTs will be charged in the normal way so tax will be due on any transfers that are made for consideration. Transfers for nil consideration and share subscriptions would both generally not give rise to a charge. There are three typical transactions that an EBT might undertake:

  1. acquisition of shares to award (either straight away or in the future) to employees
  2. the award of shares to employees pursuant to the purpose of the EBT
  3. the acquisition of shares from employees who wish to sell their shares

Transactions of types (1.) and (3.) are likely to give rise to a charge as they will be for consideration, the only exception likely to be where a type (1.) transaction is in fact a subscription for new shares and thus not chargeable. Transactions of type (2.) are unlikely to attract a charge as the employee will generally not be giving consideration for the shares.

Subject to developing an understanding of the potential costs, the government believes that in principle this exemption could be applied to a prospective new vehicle if a case can be made that there would otherwise be a tax disadvantage compared to other schemes. However, any exemption could only apply where the transaction is wholly in pursuance of the vehicle’s stated purpose.

Question 6: Would a new vehicle be at a tax disadvantage compared to other EBTs if there is no exemption from stamp duty/stamp duty reserve tax on transfers of qualifying securities between the vehicle and the beneficiaries?

Should the vehicle (which may or may not take the form of a body corporate) ultimately control more than 50 per cent of the sponsoring company, the sponsoring company should not be treated as being under the control of another body corporate, ensuring that it could continue to operate HMRC tax-advantaged schemes such as enterprise management incentive (EMI) and company share option plan (CSOP) schemes

Currently, shares in an unlisted company under the control of another unlisted company are not eligible shares for either of the SIP or SAYE tax-advantaged share schemes. Similarly, shares in a company which is controlled by another company – where those shares are not listed on the stock exchange – are not eligible shares for the CSOP tax-advantaged share scheme. These rules can exclude shares in a company which is controlled by the corporate trustee of an EBT from those schemes. There is a similar test for the Enterprise Management Incentives scheme: a company controlled by another company, including corporate trustees, does not meet the scheme’s independence requirement.

Changes to the existing rules would be needed to enable a company controlled by a potential new vehicle to participate in these schemes. The government invites views on how important such a change would be. In particular, the government made such a change to enable companies controlled by an employee ownership trust to continue to operate one of the tax-advantaged share schemes. Given this, it is not clear in what circumstances and how often companies would place a controlling shareholding in an EBT, rather than an employee ownership trust. However, it might be helpful to make this change so that a company could not unintentionally breach the requirements of one of the tax-advantaged share schemes - for example if the new vehicle were to hold a controlling interest for a short time during the course of acting as market-maker for employee shares.

Question 7: How important would this change be for the proposed new vehicle? In what circumstances and how often would companies be likely to place a controlling shareholding in the hands of a corporate trustee of a potential new vehicle, particularly given the introduction of employee ownership trusts?

Certain aspects of Part 7A ITEPA 2003 (in particular in relation to “earmarking” activities)

The OTS suggests the introduction of these anti-avoidance rules has caused significant difficulties for the operation of EBTs, irrespective of whether tax avoidance is their aim. This includes difficulties because administrators, employers and EBT trustees are prevented from sharing information about share allocation to employees because of the risk of “earmarking” and an immediate tax charge arising. The OTS recommends that a new vehicle should be exempt from certain aspects of these rules, particularly in relation to such “earmarking” activities.

Part 7A of ITEPA was introduced in 2011, with the aim of tackling arrangements which involve third parties, such as trusts used to reward employees, and seek to avoid or defer the payment of income tax. To prevent deferral of income tax, there is an occasion of charge under Part 7A when the third party “earmarks” funds in favour of the employee even though no value actually exits from the third party at this stage. There are two policy reasons for preventing deferral of income tax:

  • Deferral gives a timing advantage: from the planner’s point of view, tax deferred is tax saved. In particular, Part 7A is a safeguard against the use of employer-sponsored investment vehicles to circumvent the restrictions on pension tax relief imposed by the annual allowance and the lifetime allowance
  • Part 7A is also a safeguard against arrangements providing employment income through third parties in a way which allegedly not only defers income tax at the outset but also escapes tax at the point of exit. The earmarking charge is the first line of defence against such schemes

Part 7A is also an important safeguard against previously widespread abuse of shares and share options held in EBTs which were used to pay cash to employees avoiding NICs. This took the form of manipulating share values, loans, or creating special classes of share carrying dividends from specially created companies filled with annual bonus cash

However, Part 7A is not confined to avoidance arrangements. This is deliberate, to forestall boundary disputes and employee share schemes are thus within the scope of Part 7A. It is unclear how the current arrangements proposed for a potential new vehicle would enable a carve out to be made from Part 7A without creating an opportunity for avoidance by the minority that may wish to abuse the intended scheme, particularly as the rules will continue to apply to other EBTs. This could potentially provide a tax advantage to this new vehicle, which is not the intention of the OTS. However, as a clearer picture develops of the nature of the proposed vehicle and how it could operate, including how tightly the new vehicle could be defined, there may be opportunities to consider the application of Part 7A or alternative approaches.

Question 8: What would be the effect of continuing to apply Part 7A to a new vehicle? Is there an alternative approach, such as guidance, that could address the issue identified by the OTS and provide companies with confidence about its use of the vehicle without providing a carve out from the rules?

Question 9: More generally, do you agree with the OTS that if the government is unable to address to all (or most) of the tax issues identified by the OTS then the vehicle would not be an attractive proposition for those seeking a simpler vehicle for companies wishing to establish employee share schemes? Please explain why.

Other exemptions

The OTS also considered two further exemptions, although it did not recommend their inclusion, either because of avoidance concerns or wider policy objectives. Unless a stronger and more convincing case is made to the government by those seeking their inclusion, the OTS did not believe these were required to make the proposed vehicle a viable proposition. These were:

  • surplus funds could be returned to the sponsoring company on the winding up of the vehicle; and
  • tax relief for loans to directors from close companies would be extended beyond those either holding 5 per cent of the share capital or those spending time in actual management of the company.

Question 10: Do you agree that further exemptions are unnecessary to make the potential vehicle a viable and attractive proposition? Please explain why.

The OTS recognises the risks to the Exchequer from tax avoidance activity undertaken through EBTs and that this is an ongoing problem. The government has needed to take a number of steps in recent years to close loopholes and protect the Exchequer against avoidance using EBTs, most notably through the aforementioned disguised remuneration legislation in Finance Act 2011. It is important that any changes to promote a simpler and cheaper vehicle for those not wishing to engage in tax avoidance are accompanied with appropriate safeguards to protect the Exchequer from businesses and advisers seeking to use the legislation for purposes for which it would not be intended. As a result the OTS recommends a number of safeguards in the event that any proposal is taken forward:

  • the vehicle should be a UK resident and, if a trust, all its trustees should be UK resident
  • beneficiaries should be limited to employees and former employees rather than the wider definition under the Companies Act 2006, which includes spouses, civil partners and minor children or step-children
  • property held within the vehicle must not be applied other than for the specific purpose of encouraging or facilitating employee shareholding
  • the new vehicle may deal only with fully paid non-redeemable ordinary shares in the sponsoring company or its holding company, except in the case of a corporate transaction in cash or resulting in a share for share exchange
  • that breach of any of these conditions would mean the exemptions would no longer apply and which could, potentially, be backdated for several years unless the breach is proven to be trivial or accidental

Question 11: Do you agree that these safeguards would provide sufficient protection for the Exchequer? What, if any, opportunities would be open to those wishing to engage in tax avoidance and how could these be prevented?

These are all considered in detail below and views are invited on the government’s initial views.

The vehicle should be transparently within the UK tax system: therefore it should be UK resident and, if a trust, all its trustees should be UK resident

The Government does not have the intention of insisting that the vehicle and its trustees must be UK-based. However the exemptions proposed remove some existing barriers to setting up onshore vehicles, particularly regarding the capital gains tax on the disposal of qualifying assets to an employee for onshore EBTs, so may legitimately encourage a move to establish onshore vehicles.

Question 12: Would companies choose to establish the vehicle onshore if it could not be legislated for that the vehicle and its trustees should be UK resident?

The vehicle should exist for the purpose of enabling employees to hold or acquire shares or securities in their employing company (or in a company within their employing company’s group). So, for example, it may be appropriate to limit any beneficiaries under the trust to employees and former employees (rather than the wider definition of “employees’ share scheme” under the Companies Act 2006 which includes spouses, civil partners and minor children/step-children)

The government considers this safeguard is appropriate and required to ensure that the vehicle is used for its stated purpose. As suggested by the OTS, limiting the beneficiaries under the trust to current employees seems in line with this ambition. In particular, this would satisfy the considerations around the proposed inheritance tax exemptions by ensuring that any property applied to the vehicle is for a legitimate purpose. It may also be necessary to establish a time limit for shares held by employees who leave the company, after which charges will be incurred if the shares are not disposed of or sold.

However, as the stated purpose of the vehicle is to enable employees to hold or acquire shares, restricting the activities of the vehicle to exclude dealings with those who have significant influence over the management and direction of the company appears to also ensure it is truly for the benefit of the employees of the company. For example, all company directors and participators could be excluded, or perhaps just participators with greater than five per cent equity – this latter option is consistent with the approach taken recently to employee ownership trusts. HMRC experience suggests such vehicles are more likely to be used for tax avoidance when open to directors and participators. Examples seen previously include those where a small amount of the funds paid into a vehicle is used to benefit all employees, with normal and full deductions for tax and NICs, but no such deductions are made from much larger payments to directors and senior employees in a position to influence whether that deduction occurs. The government welcomes views on the implications of potentially placing restrictions here.

Question 13: What would be the effect be of limiting the beneficiaries to current employees? What time limit would be appropriate for former employees to redeem shares or incur charges?

Question 14: What would be the effect of excluding those who have a significant influence over the management and direction of the company? What level of restriction would be appropriate?

Property held within the vehicle must not be applied other than for a specific purpose, i.e. for the encouragement or facilitation of employee shareholding

The government agrees that there should be defined “qualifying purposes” for property held within the trust to ensure that property is used in transactions consistent with the stated purpose of the vehicle. These could be:

  • the acquisition of “qualifying securities” (i.e. fully-paid, non-redeemable ordinary shares in the sponsoring company or its holding company) or, in the event of a corporate transaction, securities in any other company acquired in consequence of a holding of shares in the sponsoring company or its holding company
  • payments or loans to a SIP
  • payments of sums to a beneficiary, providing the beneficiary is not a participator
  • transfers of qualifying securities to a beneficiary
  • the grant of employment-related securities options to beneficiaries over qualifying securities

Question 15: What would be the effect of establishing these criteria to define “qualifying purposes” for property held within the vehicle? Should any others be considered?

HMRC has noted that avoidance activities undertaken by allegedly genuine EBTs have included the transfer of real property into trust. In the case of an EBT looking to reward its employees via shares, we see no reason for an EBT to hold real property. The new vehicle may deal only with “qualifying securities” i.e. fully paid non-redeemable ordinary shares in the sponsoring company (or its holding company) – except in the case of a corporate transaction resulting in a share for share exchange; or in cash

The government agrees with the OTS that the “qualifying securities” should be restricted to those that support the stated purpose of the vehicle. The examples outlined by the OTS would seem to be in line with this ambition and the government welcomes comments on whether these are sufficient to meet the requirements of those that may wish to use a potential new vehicle.

Question 16: What would be the effect of allowing the vehicle to deal only in the “qualifying securities” recommended by the OTS? Please explain why.

The breach of any of these conditions would mean the exemptions would no longer apply and which could, potentially, be backdated for several years unless the breach is proven to be trivial or accidental

The government is keen to ensure that any potential vehicle has safeguards in place and the OTS suggestion could encourage companies considering its abuse to think twice. Legitimate users of the vehicle would not be discouraged by such a provision because they would have no intention of abusing its purpose to seek an unfair tax advantage. However, the government also recognises the retrospective nature of any such provision and is interested in the views of those who would seek to use the scheme. There may be alternatives that could have a similar effect, such as a penalty charge if the scheme is abused.

Question 17: What would be the effect of introducing safeguards that would ensure the exemptions would no longer apply and allowing this to be backdated several years if the vehicle is purposely abused by a company?

3.2 Other potential safeguards to protect the Exchequer

Initial analysis suggests other potential safeguards that would protect the Exchequer but could still support the OTS’s aims for the vehicle. In particular, consideration has been given to the types of criteria that would confirm the definition of the vehicle as one that exists for the purpose of facilitating a simpler form of employee share ownership. These could provide more certainty to businesses that the vehicle being set up delivers the benefits expected while going further to satisfy any concerns that activities within the vehicle do not represent an avoidance risk. However, the government wishes to seek views to understand the extent to which these might be necessary and whether all or some of them would materially affect the viability of the vehicle for those wishing to use it.

Potentially introducing minimum and maximum holding periods for employees

One purpose of the potential vehicle is to encourage employee ownership in the company for which they work, in a way that provides remuneration that is not disadvantaged from a tax perspective but which would benefit the employee as the company grows.

A minimum holding period for shares obtained by employees under the scheme would encourage stability in the scheme and thereby support the objective set out above, after which the benefits created by the scheme would be inferred. This would encourage employee participation in companies such that they are motivated by a clear linkage between their efforts and the potential rewards from a growth in the value of their shareholding. The government would not wish to encourage a short term view and if employees were permitted to ‘cash in’ their shareholding immediately it was obtained then this would present risks to both the Exchequer and employers. There is a risk to the Exchequer as the employee has basically had cash yet benefits from the terms of the vehicle. Equally, this creates possible funding problems for employers.

To mitigate the risks for employers they may wish for an ability to control the period within which an employee can choose to ‘cash in’ their shares, potentially utilising both a minimum and certain conditions under which shares cannot be retained. For example, we expect that employers will also want rules to allow them to force a ‘bad’ leaver to sell their shares; to make drag-along provisions that would apply where there is a company sale; and to be able to plan more clearly for the possible financial costs of funding the vehicle by setting suitable period(s) within which transactions need to happen.

As discussed above, a maximum holding period for employees who leave the company, to avoid open-ended growth in shares being exempt from tax, would help to focus the purpose of the scheme on benefitting current employees.

Question 18: What would be the effect of potentially introducing maximum and minimum holding periods for employees? What periods would be appropriate to prevent avoidance risks?

Potentially restricting the vehicle’s powers to borrow cash with which to make loans to beneficiaries, or to set up sub-funds

As the vehicle’s purpose is to create a share “marketplace” where shares can be bought and sold by employees, the need for such a vehicle to borrow cash should be limited. While the government recognise the need for the vehicle to hold cash in order to provide liquidity to an otherwise closed market, it is considered potentially necessary to restrict its use by the vehicle. We do not want to create a situation where the vehicle creates alternative possibilities for abuse whether that be by:

  • paying prices above market rates for shares from existing holders or from employees benefitting from the vehicle
  • giving the employers access to cash whilst shares are held in the vehicle by external borrowing, using the shares as security for that borrowing and so possibly encouraging a short-term view
  • using borrowed funds to make loans, possibly on non-commercial terms, to employees, which it is claimed do not generate a tax charge for the beneficiary so continuing much of the perceived current abuse of EBTs

Secondly, the legislation for employee ownership trusts has limited the ability of such trusts to set up sub-funds to ensure that such trusts are set up in order to benefit as wide a group of employees as possible rather than allowing funds to be directed to a smaller sub-set of beneficiaries. It is considered that such a restriction could be relevant and appropriate to this potential vehicle also. The use of sub-funds facilitated historic abuse of EBTs and the government would not want this situation to recur in this new vehicle.

Question 19: What would be the effect of potentially restricting the vehicle from borrowing cash to loan to beneficiaries, or to set up sub-funds?

Potentially restricting waivers by trustees on dividend and voting rights

The aim of putting shares into any new vehicle is to benefit the employees who applied for them. Ensuring that the vehicle’s trustees retain the dividend and voting rights associated with the shares put into the vehicle would give assurance that the transfer of shares to the vehicle was genuinely effective, i.e. that a transaction had taken place that created a meaningful interest in the business which would ultimately pass to employees.

If the trustees waived these rights, shareholders other than the trustees would participate disproportionately in the rights and rewards of ownership, potentially creating a tax advantage for them. A shareholder transferring shares to any new vehicle could maintain his or her original interest in the company for as long as the shares were held by the new vehicle. Any monies received by the shareholder for the transfer of his shares into the vehicle would be chargeable to capital gains.

Currently a shareholder could dispose of shares to the company (by a repurchase) but retain his current level of interest in the company because, in general, the rights carried on by those shares cease to exist once they are acquired by the company. For tax purposes the money the company gives to buy the shares would generally be treated as a distribution, giving rise to an income tax liability for the seller. If instead the shareholder could sell his shares to trustees, the consideration received from the trustees would give rise to a capital gains tax charge which is likely to be lower than the income tax charge on a similar sale to the company. A transfer of shares to the new vehicle would therefore sidestep the distribution charge resulting from a purchase of own shares, creating a tax advantage. This risk would be limited by restricting the ability of the trustees to waive share rights, as this would ensure that a shareholder selling shares to the trustees suffered a real reduction in their interest in the company.

However, the government recognises that many EBTs currently allow or impose a waiver upon the trustees, and that there are considered to be reasons for doing so. The government would therefore welcome evidence that highlights the issues that may be encountered if there was a restriction of waivers by trustees on dividend and voting rights.

Question 20: What would be the effect of restricting the ability of the trustees to waive voting and dividend rights?

Potentially requiring the shares should be attributed or applied within a specified time-frame, e.g. two years

Where the stated purpose of the vehicle is to enable employees to hold or acquire shares it would appear consistent with that aim that any shares acquired by the vehicle should be applied within a reasonable time after acquisition. Shareholding trusts have historically been abused by using them to purchase shares which are then retained or applied only to a very limited extent. The shares are not applied for the benefit of employees. Where the intention is to incentivise and benefit employees it would seem reasonable that the company should have a current and well formulated plan about how they intend to deploy those shares.

Imposing an income tax charge, equivalent to that which would arise on a distribution of profit, where shares are not applied within a reasonable time would ensure that shares are used for the intended purpose and that shares are not acquired in excess of projected requirements. This would counter the risk of company members seeking to exploit the arrangements to avoid tax on distributions. The charge would place the vendor, broadly, in the same position they would have been in had the company made a purchase of the shares.

Such a charge may be seen as punitive in some circumstances. If there were such a charge it would be consistent with wider tax principles to exclude from it any individual where they and their associates cease to have any connection with the company (leavers).

Question 21: What would be the effect of imposing a charge if shares have not been applied by the vehicle within, say, two years of acquisition? What currently drives decisions about the length of holding periods?

Potentially restricting transfers into the new vehicle

One of the purposes of this measure raised by the OTS is to encourage EBTs to set up onshore, rather than offshore as the majority are currently. A simplified, onshore vehicle is likely to be attractive to companies currently operating EBTs offshore. Many EBTs have been established for genuine commercial reasons, but as the OTS acknowledges there has been a significant level of use of these arrangements for tax avoidance. In the view of HMRC, many existing EBTs currently have substantial unresolved tax liabilities associated with them, and a key consideration is the treatment of those liabilities should the trust want to transfer into the new vehicle. It would seem reasonable that any transfer did not affect existing liabilities.

However, it is not yet clear if and how companies would choose to transfer into the new vehicle, and the government has invited views on likely take up of the new vehicle by companies currently operating EBTs, as well as companies who have been put off so far for reasons of cost or complexity.

Question 22: Would the treatment of existing liabilities associated with EBTs, as described above, affect the likelihood of transferring into the new scheme?

4. Other issues

4.1 Discussion of requirement for legislation based on model rules

The OTS considered whether to recommend legislating for a new vehicle. In particular, it was concerned that this could open up new routes for avoidance and that further legislation would create additional complexity. It therefore recommended that:

  • any new vehicle should use existing provisions
  • simply stated legislation based around model rules would be needed to exclude the vehicle from the tax provisions and introduce any safeguards

Question 23: Do you agree with the recommendations from the OTS on legislation? What, if any, supporting guidance would HMRC need to produce?

4.2 Discussion of take up of a potential new vehicle

The OTS suggests that a simpler and viable vehicle would lead to:

  • more companies and their advisers would choose to use employee ownership schemes
  • existing companies would choose to use this new vehicle instead of existing EBTs because it would be cheaper to run and administer

The government is interested in understanding the likely demand for such a vehicle by companies seeking to make arrangements for genuine equity based rewards and remuneration for employees. Taking into account the issues identified by the government that may mean it is not desirable to allow all the exemptions recommended by the OTS and the potential safeguards, it would be helpful to understand the views of companies, advisers, and share scheme experts on the likely take-up.

Question 24: What would be the nature and size of company most likely to use this vehicle if it is introduced?

Question 25: Would this be the default vehicle for companies seeking to make arrangements for genuine equity based rewards and remuneration for employees? Would there be incentive to switch from use of existing schemes? Please explain why.

Question 26: Would companies not currently incentivising and rewarding employees through such schemes now be attracted to do so if this vehicle is introduced?

Question 27: Would the vehicle encourage companies to increase the proportion of employee ownership compared to external shareholder ownership? What are the driving factors behind the allocation between the two?

Question 28: To what extent would such a vehicle reduce the administrative costs for those currently running and operating employee share ownership schemes? Please provide examples.

Question 29: Would this simpler vehicle allow companies to able to set up an employee share scheme by seeking advice from a general tax practitioner rather than a share scheme specialist? What more could be done to support that ambition?

5. Next steps

The deadline for responses to this discussion paper is 10 October 2014. Representations by email are preferable and should be sent to employeeshareholdingvehicle@hmtreasury.gsi.gov.uk. Alternatively, hard copies can be sent to:

Personal Tax Team
HM Treasury
1 Horse Guards Road
London
SW1A 2HQ

Paper copies of this document or copies in Welsh and alternative formats (large print, audio and Braille) may be obtained free of charge from the above address. This document can also be accessed from the HM Treasury website. All responses will be acknowledged, but it will not be possible to give substantive replies to individual representations.

When responding please say if you are a business, consultancy, individual or representative body. Please provide demographics of your organisation; in the case of representative bodies, please provide information on the number and nature of people you represent.

This call for evidence will inform future policy development. The government will set out its intentions once it has considered the responses received.

5.1 Confidentiality

Information provided in response to this consultation, including personal information, may be published on disclosed in accordance with the access to information regimes. These are primarily the Freedom of Information Act 2000 (FOIA), the Data Protection Act 1988 (DPA) and the Environmental Information Regulations 2004.

If you want the information that you provide to be treated as confidential, please be aware that, under the FOIA, there is a statutory Code of Practice with which public authorities must comply and which deals with, amongst other things, obligations of confidence. In view of this it would be helpful if you could explain to us why you regard the information you have provided as confidential. If we receive a request for disclosure of the information we will take full account of your explanation, but we cannot give an assurance that confidentiality can be maintained in all circumstances. An automatic confidentiality disclaimer generated by your IT system will not, of itself, be regarded as binding on HM Treasury.

HM Treasury will process your personal data in accordance with the DPA and in the majority of circumstances this will mean that your personal data will not be disclosed to third parties.