One of the less common employee benefits is the Employee Benefits Trust. Should your company offer this benefit? Find out more here
Employee benefits can be traced all the way back to the reign of Augustus Caesar, who gave retiring legionnaires in his armies a generous pension to live out the rest of their days. But as society advanced through the centuries, many more employee benefits were devised, going beyond the simple pension. One of these is the employee benefits trust.
At first glance, the employee benefits trust can appear intriguing, since it can be a way for private companies to attract and retain top talent – if it was implemented as part of employee benefits.
So, in this article, Benefits and Pensions Monitor discusses the features, pros, cons, purpose, and other relevant topics concerning the EBT. Those of you who are still unfamiliar with the EBT will surely have questions like:
- what is an employee benefit trust?
- how does an employee benefit trust work?
- should your company offer the EBT?
We’ll cover the basic questions and more. Now, let’s get into it.
Introduction to the employee benefits trust (EBT)
One of the more recent innovations in employee benefits is the employee benefits trust or EBT. EBTs play a legitimate role in companies which have an employee shares scheme or employee ownership setup. For example:
- EBTs can hold a strategic block of shares on behalf of employees for the long-term
- EBTs provide a facility for buying shares from employees participating in employee share schemes who want to opt out, or must do so because they are leaving their company
- an Employee Benefits Trust scheme allows more flexibility in allocating shares to key employees, as compared to an Employee Ownership Trust (EOT) which confers benefits to all employees on equal terms
An EBT is a legal entity. Its primary functions include:
- to acquire and hold a company’s shares on behalf of its employees
- to award those shares to employees
- to act as both a venue for storing, buying, and selling company shares to employees (in a wider employee share plan arrangement)
The characters in an employee benefits trust
To have a clearer understanding of how an EBT works, it helps to know the important characters that make up the EBT:
Settlor
Also called the Grantor, this is the creator of the trust. This is usually the company itself that creates the employee benefits trust, but the settlor may also be an individual shareholder in the company. The settlor can decide to have some shares, or a certain amount of cash placed in the trust.
Trustee
This is the person or entity that is entrusted with the safekeeping and management of the trust. Oftentimes, a trustee company is assigned the role and responsibilities of a trustee in an EBT, but it is not unusual for a company to assign one or more individuals. You may even come across the term Board of Trustees in discussions about employee trusts.
Trustees have a legal obligation to work in the best interests of the trusts’ beneficiaries. The trustees hold legal ownership of the trust and the assets held in the trust.
Depending on the size and complexity of the incentive arrangements, the trustees in EBTs may partner with third parties. This can include:
- share plan administrators
- technology and payment service providers
- brokers
- custodians
- legal advisors
- tax advisors
Trustees must also work with internal HR reward teams and company secretaries to deliver these benefits.
Beneficiaries
In an employee benefits trust, the beneficiaries are those who stand to benefit from the trust. These beneficiaries often include current employees, former employees, and their close relatives. While the trustees have legal ownership of the trust, the beneficiaries hold an equitable interest in the trust as well.
How does the employee benefits trust work?
An employee benefits trust’s main purpose is to work as an incentive to employees. Those who perform well at their jobs and have shown a high degree of loyalty are often made beneficiaries of the trust. However, there can be a vesting period before employees get access to this benefit.
Typically, the EBT is funded by the company and its employees by making contributions. It’s not uncommon for companies to secure a bank loan to fund the trust.
Why offer an employee benefits trust?
There are a few good reasons for a company to offer an EBT. HR managers and staff would do well to consider the possible benefits of establishing such a trust within their organization. An EBT as part of employees’ total benefits can do good for your company’s turnover rates.
While your company may offer some of the best employee benefits available, here are some of the most compelling reasons for adding the EBT as part of company benefits:
1. Employee benefits trusts are a way to share liquidity within the company
An EBT provides an internal market for employees to buy and sell shares.
2. EBTs give employees a sense of pride and ownership
With an employee benefits trust, the employees get to become a shareholder in their company and have a stake in the company’s success. Employees become more motivated to perform, knowing that their performance increases the company’s performance and profitability, thereby increasing the value of the shares they own.
3. EBTs are a cost-effective way to attract (and keep) top performers
Offering employees shares in your company can incentivize employees, whether new hires or tenured workers, to stay with the company for the long haul. This can also stave off poaching efforts by competing companies who may entice your employees with higher compensation packages, but without an EBT.
Getting shares can foster a sense of loyalty as well, since buying shares can require a vesting period.
For example, employees must stay at the company for a minimum of 2 years to have the option of buying shares.
Did you know Employee Ownership enhances job satisfaction.
— ESOP Association Canada (@ESOPCanada) June 20, 2024
Read the article by The National Center for Employee Ownership (NCEO) for more details on the survey at https://t.co/xqTUp5w67Z.
Learn more about employee ownership in Canada at https://t.co/6mlG5hEnCE. pic.twitter.com/c9HzPJDHD7
Want to talk to an expert on employee benefits? Check out our top pension and group benefits consultants for 2024.
4. EBTs have tax advantages for both the company and employees
Under an employee benefit trust scheme or other employee shares arrangement, shares in your company can be offered to employees without having to pay tax or file tax returns on the issuance of shares.
The capital gains tax is levied only on 50% of any profit employees get when they sell their shares, along with the appropriate income tax. The company does not pay any taxes on these capital gains.
An EBT is a tax-friendly alternative to a company buyback. Employees will only be paying the capital gains tax on the sale of their share options rather than a dividends tax if it were a buyback.
5. Employee benefits trusts enable warehousing of shares
“Warehousing” means that the EBT allows companies to have a reserve of company shares, letting the company keep these shares until they need to distribute them as incentives.
6. Employee benefits trusts prevent diluting shares
With an EBT, companies can avoid getting their shares diluted. Instead of issuing new shares, an EBT can acquire and recycle existing shares. As with stocks traded on the open market, issuing new shares increase the number of shares available, and reduce the share price.
An employee benefits trust is preferable as it holds shares in the company that sets it up; alternatives like setting up a subsidiary company do not allow this option.
The EBT enables the trustees to own shares and:
- buy and sell shares from employees who leave, as there is no other market for the shares
- give out dividends for the employees’ benefit
Disadvantages of the employee benefits trust
As attractive and advantageous as an EBT may seem, it is not without its possible drawbacks. Here are a few disadvantages to the EBT:
1. Setting it up can be complex
HR managers and staff should be prepared for the legalities and tax implications of establishing an EBT in their company. HR managers should consult with trust companies and crunch the numbers to see if setting up an employee benefits trust is truly to the company’s benefit.
2. Tax rules can be complicated
Speaking of tax implications, there can be potential tax issues:
- payments from EBTs that are based on future company performance may be partially taxable
- the CGT relief on the sale of shares may be lost if the trust sells its controlling interest before the end of the tax year that follows the sale
- the trust itself can become subject to capital gains tax if it sells its controlling interest or stops trading activity after the end of the tax year following the sale
3. Employees may get less for their shares
Although an employee can have a guaranteed sale of their shares to the EBT, the price they will get for them can be lower than if they sold to a third party. When sold back to the trust, the employee also cannot negotiate the share price.
Employee benefit trusts start out with no money, so when it comes to payments, employees may find that they will have to wait awhile or receive payment for their shares in installments. HR managers should advise retiring employees of this caveat; it can be very inconvenient for employees of retirement age to wait for payment for their shares.
What is an employee ownership trust (EOT)?
As you find out more about the EBT, you may stumble upon a similar-sounding term: employee ownership trust or EOT. An employee benefits trust is a form of EOT.
In an EOT, ownership of the company’s shares, or holding shares that represent a controlling stake at the very least, is transferred by specific shareholders (usually the company’s founders), to its employees.
Watch this video to find out more about EOTs, focusing on their structure, relevance in Canada, and comparisons with US and UK models:
The main difference between the EBT and the EOT is that not all employees are required or allowed to participate in an EBT. Companies set up an EBT for the employees’ benefit. Companies or individual shareholders sell a majority stake to an EOT to turn the company into an employee-owned entity.
Basic Rules on EBTs in Canada
There can be many rules covering the different aspects of an employee benefits trust in Canada. For an EBT to be considered as such, it must:
- be an irrevocable trust
- be created exclusively for the benefit of beneficiaries, which can include current or former employees and their immediate family members
- have trustees that may be individuals and employees of the company, shareholders, founders, or a trust company or other entity that offers trustee services; trustees must be resident in Canada
- be a trust deed or trust document drafted by the settlor
- have at least 90% of the fair market value (FMV) of the property of the trust as shares of one or more qualifying businesses (QBs) that the trust controls
- have at least 50% of the employee beneficiaries approve transactions or events prior to their occurrence
For a more detailed explanation on the requirements, refer to the pages of the Canada Revenue Agency (CRA).
Offering an employee benefits trust is not a decision to be made on a whim. HR managers, employee representatives, and business owners should plan and decide together if an EBT is a worthy addition to their current roster of employee benefits. To provide any real advantage, an EBT must be created with the best interests of the company and its employees in mind.
An EBT does not immediately give financial benefits, which are what many employees look for in an employer nowadays. Just the same, its potential to foster long-term employee loyalty and engagement through shared ownership and stability can be invaluable. Not just to employees, but to employers and the wider organization too.
Do you think an employee benefits trust can round out your company’s total benefits package? Let us know in the comments
