This October saw the introduction of a new tax relief, allowing companies that are majority employee-owned to pay their employees bonuses free of income tax.
The relief is available for a company controlled by an employee ownership trust, and is the sister to a separate tax relief introduced earlier this year under which shareholders selling a controlling interest to an employee ownership trust can claim a complete exemption from capital gains tax.
The policy goal is to encourage more companies to move to employee ownership, the government believing this will help create a range of benefits, including increased productivity, improved performance and an increased sharing among employees of the resulting financial benefits.
There is much research evidence to support their view that employee ownership improves performance, and the government-commissioned 2012 Nuttall Review of Employee Ownership made a number of recommendations for achieving a significant growth in this area.
How the relief works
Bonuses paid to employees of a company or group which is controlled by an employee ownership trust will be exempt from income tax, up to an annual limit of £3,600 per employee. National insurance, however, will still be payable. There are a number of key conditions for the new relief.
Trading company: The employer company must be a trading company or a member of a trading group for the period of 12 months up to date when the payment is made (the qualifying period).
Employee ownership trust has controlling interest: A controlling interest in the company must be held by an employee ownership trust throughout the qualifying period (although for this purpose, the period begins when a controlling interest was acquired). This means that a company which becomes controlled by an employee ownership trust will have to wait 12 months before being able to use the tax relief.
All employees participate: All employees must be eligible to participate in any bonus award (although a minimum period of employment of up to 12 months can be specified) and any bonuses must be paid on the same terms (the equality requirement). The company cannot, therefore, skew income tax free bonuses to the advantage of particular employees, although it can allocate benefits of differing amounts by reference to factors such as salary, length of service or hours worked. There is nothing to prevent it from paying bonuses that do not meet the equality requirement, so long as it accepts these will not benefit from the income tax relief. Employees can also include former employees.
Not permitted in companies with very small numbers of employees: The company must not have more than a ratio of 2:5 for office holders and directors to employees, to prevent the relief being used primarily for the benefit of directors of smaller companies.
Genuine bonus: The payment must not consist of normal salary and must not be made by a service company.
Why employee ownership trusts?
Companies can be employee-owned through individual share ownership, and many are. Existing tax reliefs provide employees with incentives to acquire shares in their company, for example the Share Incentive Plan or SIP which gives employees income tax (and national insurance) relief on the cost of buying shares and exempts awards of free shares from income tax and NI. dividends paid on individuals’ shares are taxed at preferential rates compared to employee income tax.
However, employee ownership through a trust, with no or limited individual share ownership, is an alternative model. Simpler to administer than individual employee share ownership and a convenient vehicle for transferring a company’s ownership from its founders to employees, the intention is that the creation of new tax reliefs associated with this form of employee ownership will encourage more companies to go down this route.
Employee benefit trusts have in past years been used for creative high value remuneration tax planning in ways which have not found favour with HM Revenue and Customs, and anti-avoidance provisions have now closed down those routes. This new statutory tax relief, which is only available where bonuses are paid to all employees on the same terms, is wholly different in its application.
This new tax relief may be unlikely on its own to encourage a company to move to employee ownership (or to structure a start-up in this way), but if it is considering the wider potential merits of employee ownership the ability to pay annual income tax free bonuses of up to £3,600 per employee may be one good reason for giving it serious consideration.
Robert Postlethwaite is Managing Director of Postlethwaite, solicitors specialising in employee share plans and employee ownership