Employee share ownership and employee benefit trusts

It is a truth universally acknowledged that employee ownership of businesses is inherently desirable. Despite this and the introduction of numerous schemes over the years to encourage employee ownership, take up of those schemes amongst smaller companies has been extremely limited.

In part this is because employee share ownership brings with it a number of practical issues, such as: how do you manage a company with numerous employee shareholders; and, what do you do when an employee shareholder leaves the business?

To some extent these issues were addressed by the introduction of employee benefit trusts, known as EBTs, under which shares are held by trustees for the benefit of the employees of the company.

EBTs allow employees to share dividends paid by a company and, when that company is sold, share in the proceeds of sale but otherwise give individual employees no direct interest in the shares held by the trust. In theory this ought to work, but in practice take up has remained low.

In the hope of encouraging more widespread employee share ownership the Finance Act 2014 introduced new tax reliefs in relation to companies owned by an employee ownership trust, which is a form of EBT which included 100% relief from capital gains tax for a disposal of shares to an EOT.  So, given that business owners can now sell upwards of half of their shares in a company to an EOT for their full market value without paying any capital gains tax on the proceeds, has this at last achieved the desired effect? In short the answer is no.

The problem is simply this: where will an EOT find the money to buy the shares? An EOT is unlikely to be able to borrow the money from a bank without the company guaranteeing the loan which may substantially impact upon its ability to fund its business going forward. Alternatively, the business owner might accept payment by instalments from dividends paid to the EOT, but the trustees would have to pay income tax on those dividends, which wipes out the tax advantage of using an EOT at a stroke.

Until this fundamental issue is addressed, widespread employee share ownership in smaller companies is likely to remain a pipe dream.