What is an ESOT/EBT ?

A company establishes an ESOT/EBT which acquires new or existing shares in the company, usually funding the acquisition by external funding.

The trust then holds the shares for a number of years for distribution to employees either directly [an EBT(in which case a Schedule E charge will arise)] or via an approved scheme [ESOT(which will normally be tax free)]

The trust then repays its borrowings out of voluntary contributions made by the company which will be deductible for Corporation Tax purposes (providing certain conditions are met)

Shares may be acquired at a low price for distribution to employees up to 20 years later - which may be useful if a floatation or management buyout is envisaged.

Such schemes are a cheap and effective way of raising funds since effectively the trust provides the company with extra funds, which it raises from external sources. Yet, at the same time, Corporation Tax Relief is available on all the contributions made into the trust (other than the money the employer contributes to set up the trust which is capital expenditure and therefore not an allowable deduction in computing the employers Schedule D profits) whether they are used to repay interest or capital.

The trust can be used to buy considerable shareholdings from a departing or retiring shareholder where the existing shareholders do not wish to lose control of the company but cannot raise the necessary funds to acquire the shares themselves.

The trust can be used to formulate an internal share market for unquoted companies, which will enable employees to buy and sell shares.

Such schemes make it possible to make greater distributions to employees than under an approved profit sharing scheme, since there are no monetary limits on distributions.

To become an approved scheme, an ESOT, the trust must satisfy a number of conditions. The main ones of which are set out below: -

The trust must be established by a company which at the time of the trusts establishment, is resident in the UK and not controlled by another company.
The trust must be established under a deed (the trust deed)

There must be at least 3 trustees all of whom are resident in the UK, and one of which must either be a trust corporation, a solicitor or a member of another recognised professional body.

The beneficiaries must include all directors or employees of the company or a group company who have been employed for a minimum period specified in the trust deed (not more than 5 years) during which time they have worked for at least 20 hours a week. This may include ex-employees or ex-directors of the company who satisfied the minimum period of employment, provided their departure was within the last 18 months.

A person cannot be a beneficiary if at that time he has a 'material interest' in the founding company or at any time in the previous year has had a material interest in that company.

'Material Interest' is defined as beneficial ownership of or ability to control more than 5% of the ordinary share capital or entitlement to more than 5% of the assets in a winding-up.

Any sums received by the trustees must be expended within 9 months of receipt, or, if it is received from the funding company, or a company which is controlled by that company at the time the sum is received, within 9 months of the end of the companies period of account in which the expense is charged.

Sums received by the trust must be kept as cash or kept in an account in a bank or building society until it is used. Sums received are treated as being expended on a First In First Out basis.

The trust deed must provide that where trustees pay sums to different beneficiaries at particular times that sums must be paid on similar terms which may vary only according to their level of remuneration, length of service or other similar factors.

The shares acquired by the trustees must be shares in the founding company which: -
form part of the companies ordinary share capital;
are fully paid-up;
are not redeemable; and
are not subject to any restrictions other than restrictions attaching all shares of the same class, or a restriction authorised by Para 7(2) Sch 5 FA 1989.

The trust deed must provide that shares in the founding company may not be acquired by the trustees at a price they might not reasonably be expected to fetch on the open market, normally shares be acquired at a time when that company is controlled by another company.

When the trustees transfer shares to a beneficiary, they must be transferred to all beneficiaries on similar terms although these may vary according to their level of remuneration, their length of service or similar factors.