The Chartered Institution of Taxation (CIOT) Budget representations for October 2021: Enterprise management incentive (EMI) share schemes and employee ownership trusts (EOTs)
The CIOT has recently published the budget representations it submitted to HM Treasury on 4 October 2021 regarding EOTs and EMI share schemes. Notably, amongst a range of topics covered, it has suggested:
- a broadening of the application of the Enterprise Management Incentive (EMI) and other tax-advantaged employee share option schemes; and
- the introduction of new restrictions to crack down on the use of EOTs solely as a tax planning measure.
The CIOT’s Budget representations include some general recommendations to extend the qualifying criteria for EMI schemes, which will be welcome news to the owners of many companies that only marginally fail to qualify for the scheme.
EMI schemes are a type of share option scheme, enabling qualifying companies to incentivise their employees by providing them with share options subject to favourable tax treatment.
The CIOT believes that the EMI scheme is fulfilling its objective of assisting small to medium sized businesses attract and retain employees, but advises that the scheme should be extended to include more companies within its scope. Widening the eligibility criteria, the CIOT believes, will help more companies achieve much needed growth in the wake of the COVID-19 pandemic.
In particular, the CIOT suggests:
- increasing the threshold requirements for the number of qualifying employees and gross asset value to account for inflation and current business needs; and
- fixing these for a period of 12 to 18 months to help companies whose employee numbers or gross assets frequently fluctuate above and below the qualifying limits.
These changes would be more administratively convenient for the relevant company and HMRC, as it would make it easier to ascertain whether or not a company qualifies over a given period of time.
The CIOT further highlights that the recent changes to working arrangements should be reflected in EMI scheme requirements. This flexibility could be achieved by relaxing the number of hours per week (or proportion of their working time) an employee must work for the relevant company and reducing the list of trades that are currently excluded from the scheme.
The CIOT also suggests that the government review the eligibility criteria, and respective limits, of the other tax-advantaged share schemes to assist businesses that do not qualify for EMI schemes but still wish to incentivise their employees in a similar way.
The CIOT also submitted a separate, detailed Budget representation specifically on EOTs.
An EOT is a structure designed to allow UK businesses to convert to employee ownership. The original owner(s) transfer shares in a company to an EOT, which holds the shares on trust for the company employees. EOT tax reliefs were first introduced in the Finance Act 2014 following the recommendations of the Nuttall Review, which was commissioned by the government to review the benefits of employee ownership. Broadly speaking, the original owners benefit from capital gains tax (CGT) relief on the transfer of a controlling interest to the EOT. Employees of the company can then benefit from income tax relief on bonus payments of up to £3,600 per year.
The CIOT has identified several issues with the current operation of the EOT reliefs and recommended a review of the provisions as soon as possible. In particular, the CIOT notes that, in its view, EOTs are on occasion being used as a tax planning measure with no real intention to transfer ownership to employees in the long term. In addition, the practice of companies seeking non-statutory HMRC clearance on the proposed structure of the transfer of shares to the EOT creates unnecessary expense and administrative burden for both HMRC and the relevant trading company. The CIOT provides three key proposals to address these concerns.
The first proposal is for the government to explicitly confirm in the legislation that contributions paid by the trading company to put its EOT in funds to pay the consideration relating to the acquisition of company shares are non-taxable in the hands of the trustees. HMRC has, in its replies to non-statutory clearance applications, indicated that it would not tax these contributions as dividends once in the hands of trustees. However, advisers are understandably cautious and tend to advise companies to apply to HMRC for a pre-transaction ruling to ensure that no tax will be payable. The CIOT considers these applications unnecessary – the purpose of the EOT is to make it tax efficient to transfer ownership of a company to employees and thus making the contributions taxable in the hands of trustees would undermine the policy intention of CGT relief (as dividends are taxed at higher rates than capital gains). Putting this principle of non-taxability on a statutory footing would eliminate the need for clearance and allow the government to carve out provisions to avoid any potential abuse.
The second proposal is to ensure commitment to employee engagement by:
- restricting the use of offshore trustees; and
- requiring a majority of trustees to be unconnected to the shareholder selling their shares to the EOT.
The CIOT noted the increasing use of offshore trustees as a tax planning measure – offshore trustees have no CGT liability on disposals from the EOT and can effectively turn the CGT deferral into an outright CGT exemption. This means that a company’s shares can be sold to an EOT for a deferred price and, once the tax reliefs have been cemented, the offshore trustees can then sell the shares onto the intended purchaser and pay the sale price to the original seller without incurring a CGT liability. While the CIOT is unclear whether this was a deliberate policy decision, it insists that use of the EOT solely for tax planning purposes leads to trustees being primarily concerned with the interests of the seller, resulting in EOTs not achieving the intended economic and social benefits of increased employee engagement. The CIOT has therefore recommended that the government require trustees to be UK resident or treat non-UK resident trustees as UK resident to ensure that future growth in the company remains within the scope of CGT. If the government is not inclined to take this approach, the CIOT has alternatively suggested introducing rules similar to the existing rules on offshore trusts, whereby the trustees would be required to apportion gains made by the EOT to UK resident beneficiaries. The CIOT further suggests that a requirement for the majority of trustees to be unconnected to the seller would force trustees to focus on employee engagement as soon as possible, and not solely on repaying the deferred consideration to the seller.
The third proposal is to streamline the process for shareholders selling to an EOT to apply for CGT relief. Currently, there is no dedicated route for making such a claim on the self-assessment tax return; applicants must claim under the “other” code and provide “full details”, making it unclear what information needs to be supplied. The CIOT believes that the creation of a designated code for EOT relief would make it easier for applicants and assist HMRC in dealing with compliance and keeping track of the number of EOTs.
In its Budget representations, the CIOT has recommended an extension of the EMI scheme and a fairly comprehensive review of the rules underpinning EOT relief. For each recommendation in relation to the EOT rules, the CIOT provides a series of different options to allow scope for some change in the intended direction without being unrealistic or impractical – for example, the CIOT recognises that the government may be hesitant to require all EOT trustees to be UK resident in case this discourages companies focusing on international growth. It will be interesting to see if and how the government responds to these recommendations.
For further information please contact Robert Birchall at Robert.Birchall@crsblaw.com.