How does an Employee Benefit Trust avoid Capital gains tax both on properties and/or on investments and save inheritance tax very quickly?
An Employee Benefit Trust is often set up for people with property portfolios who have made significant capital gains on their properties. CGT has become a serious issue for property landlords since the capital gains tax allowance was reduced in November 2022. This is also true for people who have significant investment assets. If you sell or gift properties or investments the Capital Gains Tax will be immediately payable.
How can an Employee benefit Trust help?
First of all, if you have properties and you own them personally, we will need to set up a Limited Liability Partnership first because you can’t move the properties immediately into a company otherwise the accumulated CGT will be immediately payable. Three years later we set up a Family Investment Company and then the properties are conveyed in exchange for capital shares. These shares are different to the shares of a normal limited company in that they are set up to contain no voting rights or rights to income. Income is distributed by means of a separate class of shares called income shares. If you have an existing company, it must also be converted into an FIC first – you need to have control if you will give the shares of the company away to the Employee Benefit Trust.
Once the FIC is set up, the capital shares are then passed into the Employee Benefit Trust which is a special type of discretionary trust which must have a sponsoring employer. The employees of the company who are also the beneficiaries of the trust should only be family bloodline – children and grandchildren, and they must be paid a small monthly salary. Non-family members must not be employees because all the employees have to benefit from the Employee Benefit Trust. If other employees are required to manage a large portfolio of assets, then a separate servicing company should be set up to employ those people and then invoice the FIC for salaries and costs.
The Employee Benefit Trust achieves a number of immediate benefits. The shares pass into the EBT and are outside of your estate immediately – there is no 7-year waiting period. For people who already have existing companies this can be done very quickly and within a month you can reduce the value of your estate significantly. There is also no Capital Gains Tax to pay because we claim holdover relief as it is an option in any discretionary trust. With holdover relief this means that the CGT is not wiped out but simply deferred into the trust.
However, when the original settlor dies, the CGT dies with them. At that point – on the death of the original shareholders, a few other things can happen. As the CGT has already been wiped out, the EBT can then pass the shares of the company back to the company employees. The beneficiaries of the EBT are usually your children and adult grandchildren and they must be employees of the company. Your children can then set up their own EBT and put the capital shares back in and, if they have accumulated growth in the company and want to solve their own IHT problems, they could also put growth shares into the EBT at the time.
Due to the huge amount of Capital Gains Tax it can save within existing companies and the immediate inheritance tax benefits, an Employee Benefit Trust is very useful for professional landlords to avoid CGT and IHT; people with existing companies where they have built large investment or cash values; people who wish to move high values of assets outside of their estate without waiting the normal 7 years.
An EBT is a very useful vehicle but not cheap to set up – it can cost around £10,000 but it can save hundreds of thousands in Capital Gains Tax and inheritance tax. Due to their complexity, employee benefit trusts carry a lot of restrictions which you have to adhere to. Experienced advice must be taken.