Approved Profit Sharing Schemes (APSSs) and Employee Share Ownership Trusts (ESOTs)

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1 [17.1.2] Profit Sharing Schemes Approved Profit Sharing Schemes (APSSs) and Employee Share Ownership Trusts (ESOTs) Reviewed April Introduction Legislation in respect of approved Employee Share Ownership Trusts (ESOTs) was introduced by the Finance Act 1997 following commitments entered into by the Government and the Social Partners to deepen partnership and secure commitment at the level of the enterprise. The legislation is contained in Chapter 2 of Part 17, Taxes Consolidation Act, 1997 and Schedule 12 of that Act. In Ireland, ESOTs have been used mainly as a mechanism to give employees of State and Semi State companies free shares in these companies on sale or privatisation. An ESOT is, in many ways, similar to an Approved Profit Sharing Scheme (APSS) - it is essentially a trust established by a company for the purpose of placing company shares into the hands of employees. However the ESOT has, in some ways, less constraints than an APSS in that: the APSS has only one principle source of funds - direct contributions from the employer company whilst the ESOT, on the other hand, can obtain finance from a number of sources (for example, it can borrow money, earn dividends as well as take contributions from the employer company); the APSS must appropriate the shares to employees within 18 months of their acquisition whereas the ESOT can hold the shares for up to 20 years. A Revenue approved ESOT must meet certain legislative requirements including that: it must be established by a trust deed;# the company establishing the ESOT must not be under the control of another company. As in an APSS, where the company establishing the ESOT has control of another company or companies, a group scheme can be established to include 1

2 some or all of the group companies. However a scheme will not be approved that will result in shares being appropriated wholly or mainly to the higher paid employees/directors in the group of companies. 2. General The purpose of this Instruction is to provide staff with a general overview of the tax legislation governing an ESOT. 2.1 Tax Reliefs Chapters 1 and 2, Part 17, Taxes Consolidation Act, 1997 provide for: Re Employees relief from income tax for eligible employees/directors who on or after 6 April 1997 have ordinary shares appropriated to them under an APSS linked to an approved ESOT; Re Companies a deduction from corporation tax in respect of the costs of establishing an approved ESOT on or after the 6 April 1997 and for any payments made to the trustees which are expended in the expenditure period for qualifying purposes (see paragraph 4), Re an ESOT an exemption from income tax for the trustees of an ESOT in respect of income accruing to the trust in so far as that income consists of dividends, and only to the extent that such income is expended within the expenditure period for qualifying purposes. (see paragraph 4), [No tax credit will arise in respect of such dividends]; an exemption from CGT for the trustees of an ESOT on any shares transferred by them to the trustees of an APSS; an exemption from CGT for the trustees of an ESOT on any shares sold by them on the open market but only to the extent that the proceeds of sale are used to: repay borrowings by those trustees, to pay interest on the borrowings, or to pay a sum to the personal representatives of a deceased beneficiary. 2

3 2.2 Administration Approval of an ESOT Matters relating to- the approval of an ESOT; any appeal against a decision of the Revenue Commissioners not to approve a scheme; or any point of doubt or difficulty in relation to the legislation or its application in particular cases. are dealt with by Employee Share Scheme Section, Personal Income Tax 1, Income and Capital Taxes Division, Dublin Castle, Dublin 2. Where a scheme is approved, Personal Income Tax Branch will update the CRS case notes for the Participating Companies. Beneficiaries of an ESOT The Customer Services District dealing with the beneficiaries of an ESOT will not be concerned with the legislation unless a charge to tax arises. Personal Income Tax Branch, Income and Capital Taxes Division, will advise the relevant District when a charge to Income Tax arises. Corporation Tax deduction Issues relating to the Corporation Tax deduction for expenses incurred in the establishment of the scheme and for payments made by the company to the trustees of the scheme are matters for the District dealing with the company (or group of companies). Tax affairs of the ESOT All matters relating to the tax liabilities on income/gains arising to the ESOT are dealt with in the District dealing with the trust. 3. Beneficiaries The legislation governing the approval of an ESOT specifies that certain individuals of Participating Companies must be included as beneficiaries of the relevant ESOT. These include: all employees, and 3

4 directors who work at a rate of at least 20 hours per week who are chargeable to Income Tax under Schedule E and satisfy an optional qualifying service period, which cannot exceed 3 years. Certain other persons can also be included: employees/directors who are not chargeable to Income Tax under Schedule E; former employees/directors who left the company within the preceding 18 months; in the case of the ESB ESOT, former employees/directors who were employees/directors of a Participating Company of the ESB ESOT on 1 January 1998; former employees who left the company within 20 years (from 1 January 2014, previously 15 years) of the trust being established where a loan is in place (to finance the purchase of the shares put into the ESOT) and 50% or more of the shares are pledged as security for that loan; and a charity, where there is no other beneficiary and the trust is in consequence being wound up. A person who has, or had at any time in the preceding year, a material interest 1 in any participating company cannot be included as a beneficiary. 4. Sums received by the Trustees of an ESOT Any sums received by the trustees of an ESOT must be expended within the expenditure period for one or more qualifying purposes and, while held by the trustees, be kept as cash or on account with a relevant deposit taker. The expenditure period is: where the sum has been received from the company, 9 months following the end of the accounting period in which the sum is expended by the company; and in any other case 9 months from the date it is received. 1 An individual in the case of an approved ESOT has a material interest in a company where he or she is able to control, directly or indirectly, more than 5% of the share capital of the company. 4

5 Each of the following is a qualifying purpose: acquisition of shares in the founding company (the company establishing the ESOT); repayment of sums borrowed; payment of interest on sums borrowed; payment of any sum to a person who is a beneficiary under the terms of the trust deed; payment of any sum or the transfer of securities to the personal representatives of a deceased beneficiary under the terms of the trust deed; and meeting of expenses. When the trustees pay sums to different beneficiaries at the same time all sums must be paid on similar terms. 5. Charge to Income tax in the hands of employees / directors 5.1 Annual Limit An ESOT works in tandem with an APSS. Shares are transferred by the trustees of the ESOT to the trustees of an APSS for onward appropriation to eligible employees/directors ( participants ). The maximum market value of shares that can be appropriated from the trustees of an APSS in any one income tax year to any one participant is 12,700. In exceptional circumstances, where the following conditions are met, the maximum value of shares that can be appropriated to a participant is 38,100: the shares appropriated to the participant have been transferred by the trustees of the approved ESOT to the trustees of the APSS; at all times in the 5 years since the approved ESOT was established or such shorter period as the Minister for Finance may allow, 50 per cent of the securities, or such lesser amount as the Minister may allow, held by the trustees at the time were pledged as security for borrowings; at the time the shares were transferred by the trustees of the ESOT to the trustees of the APSS a period of at least 10 years 2, commencing on the date 2 For a period of at least 10 years up to and including 30/01/2008; for a period of at 5

6 the ESOT was established and ending at the time when all the shares pledged as security for borrowings became unpledged, has elapsed ( encumbered period ); none of the shares pledged at any time since the approved ESOT was established have been transferred from the trustees of the approved ESOT to the trustees of the APSS because they have been pledged for the period of 10 years or more referred to above. The maximum of 38,100 referred to above only applies in the first year of assessment during which the encumbered period has elapsed and only in respect of shares appropriated after that period has elapsed. 5.2 Period of Retention of shares To qualify for the income tax relief referred to at paragraph 2.2 above, for employees, the shares appropriated to a participant must be held in the APSS for a period of three years ( release date ) Where the shares are retained in the approved ESOT and APSS, for an aggregate period of three years and the individual has been a beneficiary of the approved ESOT for three years no income tax charge will arise when the shares are passed to the individual at the end of the three year release date. 5.3 Payment of Cash from an approved ESOT In some instances an approved ESOT may have cash it received from one of the Participating Companies or from dividends which cannot be used for qualifying purposes (e.g. there may be a limit on the shareholding the ESOT can hold, and consequently the trustees will be unable to use the cash received from Participating Companies to purchase additional shares in the founding company). Where this surplus cash is paid to the beneficiaries of the approved ESOT, these payments are regarded as emoluments of the employees, and consequently chargeable to tax under Schedule E. In these circumstances, the trustees of the ESOT must register for PAYE/PRSI and make the necessary deductions from any such cash payments made to the beneficiaries (employees/directors or former employees/directors). 5.4 Payment of cash from an approved ESOT where the cash was originally received by the approved ESOT in the form of a dividend As set out in paragraph 5.3, payments of cash made to beneficiaries from an ESOT are taxable and subject to deductions under the PAYE system. least 10 years or such period (not being less than the period referred to in Paragraph 515(2A)(b) of TCA, 1997) as the Revenue Commissioners may allow, as on and from 31/01/08. This change was introduced by Section 14 of Finance Act

7 However, an amendment was introduced by Section 18 3 of the Finance Act 2005 whereby payments (which originated as dividends paid to the approved ESOT on shares held by the trustees) made to the beneficiaries of an approved ESOT (which is linked with an APSS) will be treated as distributions and, accordingly, Dividend Withholding Tax (DWT) will apply. Certain requirements must be met for this treatment to apply. Districts will not be concerned with these requirements. The approved ESOT will apply the DWT where relevant payments are being made and the beneficiary will be given a counterfoil to show the distribution and the amount of DWT deducted. The distribution will be subject to the normal tax treatment in the beneficiaries hands. The individual will be liable to income tax at his or her marginal rate subject to a credit for the DWT. The beneficiary must make a return of the distribution in the normal manner. 3 Section 18 of the Finance Act 2005 applies to relevant payments made to beneficiaries by an approved ESOT on or after 3 February