Employee Benefit Trusts

What are Employee Benefit Trusts?

Typically, an Employee Benefit Trust is established by a company (usually with shareholder approval) and an independent trustee appointed. In general, the trustee has broad discretion over the shares and how they will be used to benefit employees.

Why do companies establish Employee Benefit Trusts?

Many companies, both listed and unlisted, establish share incentive arrangements to enable employees and senior executives to become shareholders in the business for which they work.
There are several types of employee share incentive arrangements which are commonly implemented. Companies will have different objectives in designing an employee share incentive arrangement, for example:-

• a private company which is approaching flotation may prefer schemes that not only enhance employee’s opportunities to participate in the flotation but also lock them in for a period after flotation;
• a closely held private company may wish to allow employees to share in the capital growth of the company but will be concerned about dilution and a market for the shares; and
• a listed company may be prepared to operate more complex and varied arrangements to widen employee participation or to supplement or replace existing schemes for its senior managers and executives.
• The use of EBTs for funding employee share incentive arrangements has become commonplace in many countries, particularly among those in Western Europe, because in some countries:-
• there is a legal prohibition on a company holding treasury stock, as was the case in the United Kingdom (“UK”) until December 2003;
• there are institutional investor or stock exchange rules that limit the number of new shares a company may issue to satisfy employee share incentive arrangements, but do not limit existing shares that may be used for these purposes, and
• as is the case in the UK, corporate law bars or effectively discourages (by requiring independent valuations, reports, etc) companies from issuing free shares directly to their employees.

Consequently, many companies use EBTs to purchase shares in the public markets in order to overcome the constraints, to help limit future dilution or simply to hold shares earmarked for future employee share incentive arrangements.

While the recent change in the UK corporate law allows public companies to use treasury shares to compensate employees, in practice UK companies continue to use EBTs due to the significant requirements for approvals, reporting obligations and the number of UK company law issues that arise if a UK company decides to use treasury shares for this purpose.

Treasury shares are unlikely to dispense with the use of EBTs, because:

• treasury shares have no dividend rights, EBTs will continue to be needed for schemes in which participating employees are entitled to dividends before they become registered shareholders;
• many UK companies operate EBTs to circumvent the anti-dilution limits in the ABIs employee share schemes guidelines, ABI treat the transfer of treasury shares as if it were the issue of new shares; and
• the restrictions in the Listing Rules on the timing of share transfers to employees are more onerous for treasury shares than for independent EBTs.

For private companies EBTs can act as a market maker. This can be of enormous benefit since, without a market, employee share incentive arrangements can be perceived by employees as worthless thus negating the whole point of establishing such arrangements.

If properly structured, EBTs may also offer some fairly significant tax advantages to companies and its employees. As an example, in the UK, if someone sells shares back to their employer, they may be regarded, for tax purposes, as receiving a distribution, which is equivalent to a dividend. By way of contrast, a sale to an employee benefit trust is currently treated as a capital gain. In the current UK tax climate, that can be a major advantage to the vendor.

How IFG can help?

IFG has extensive experience in the establishment and ongoing administration of Employee Benefit Trusts.

IFG does not provide taxation or legal advice. The information and expression of opinion expressed in this briefing note are not intended to be a comprehensive study or to provide taxation or legal advice. Specific advice concerning individual situations should be taken and IFG can provide introductions to advisers who specialise in this area.