Employee Benefit Trusts (EBTs) and IHT: The Section 86 IHTA 1984 Exemption and Employee Ownership Trusts
A transfer to a qualifying Employee Benefit Trust is exempt from IHT under s86 IHTA 1984 — no initial charge, no 10-year periodic charge, no exit charge. But the trust must genuinely benefit all or most employees, not just the owner-director. HMRC aggressively attacks non-qualifying EBTs as disguised remuneration. An Employee Ownership Trust (EOT) adds a CGT exemption on the business sale.
EBTs and IHT: Key Rules
The s86 IHTA 1984 employee trust exemption
Section 86 IHTA 1984 provides that a transfer of value is exempt from IHT where it is a transfer to a trust which qualifies as an 'employee trust' — i.e. a trust under which the settled property may be applied for the benefit of: (1) all or most of the persons who are (or have been) employed by, or hold (or have held) office with, a company; and (2) their dependants. The exemption applies to all IHT charges: (a) the initial transfer into the trust (no chargeable lifetime transfer or PET); (b) 10-year periodic charges (the s86 trust is exempt from the relevant property regime); and (c) exit charges on appointments out of the trust to qualifying beneficiaries. The exemption is powerful — a business owner can transfer significant business assets to an EBT without triggering IHT, provided the qualifying conditions are met.
Qualifying conditions for the s86 exemption
To qualify for the s86 IHT exemption, the EBT must satisfy: (1) Class of beneficiaries: the trust deed must permit the trustee to benefit all or most of the employees (and former employees) of the company — not just senior employees, directors, or shareholders. A trust that restricts its class to 'directors' or 'senior managers' does not qualify. The 'all or most' test requires a broad class covering the majority of the workforce. (2) Purpose: the settled property must be capable of benefiting the broad class of employees — not structured so that in practice only one or two individuals (typically the owner-director) will benefit. (3) No excluded participator provisions: if the settlor has an interest in the company as a participator (shareholder) and the trust is structured to benefit the settlor or associated persons disproportionately, HMRC will challenge the exemption. (4) Company must exist: the employees must be employees of a company (not a partnership or LLP — s86 is company-specific).
HMRC's attack on non-qualifying EBTs: disguised remuneration
Many EBTs established in the 1990s and 2000s were used primarily to benefit owner-directors — paying them through loans or other mechanisms that were not taxed as income. HMRC challenged these extensively, and Finance Act 2011 introduced the disguised remuneration rules (Part 7A ITEPA 2003) — charging income tax and NICs on EBT loans and benefits that had not been taxed as employment income. The 2019 loan charge brought historical EBT loans made from 1999 to 2019 into charge (at 2019/20 income tax rates) unless the arrangement was fully disclosed and settled. EBTs that failed the s86 qualifying conditions — because in practice only owner-directors benefited — are also treated as making chargeable transfers for IHT: the initial transfer to the EBT is a CLT (IHT at 20% above the NRB), and the trust is subject to 10-year periodic charges and exit charges as relevant property.
Employee Ownership Trusts (EOTs) — a qualifying EBT with special CGT relief
An Employee Ownership Trust (EOT) is a specific type of qualifying EBT introduced by FA 2014. An EOT must: (1) hold a controlling interest in a qualifying company (more than 50% of ordinary share capital); (2) have a broad class of beneficiaries (all qualifying employees); and (3) satisfy the equality requirement (participatory benefits must be on equal terms or by reference to remuneration, length of service, and hours worked — not on discretionary terms). Where an individual sells shares in a company to an EOT on arm's length terms: (a) the individual vendor pays no CGT on the disposal of the shares to the EOT; and (b) the EOT acquires the shares and can pay a tax-free bonus of up to £3,600 per qualifying employee per year. The EOT sale is also exempt from IHT as a qualifying s86 transfer. EOTs are increasingly used for business succession — allowing the founder to exit the business without CGT, transfer control to employees, and reduce IHT exposure.
IHT on distributions from an EBT to beneficiaries
Where a qualifying s86 EBT makes a distribution to a beneficiary (employee or former employee), the distribution is an exit from the trust. For a qualifying s86 trust, the exit is exempt from the IHT exit charge (that would otherwise apply to distributions from a relevant property trust). The beneficiary receives the distribution as an employee benefit — which may be subject to income tax and NICs as employment income (depending on the nature of the benefit: cash, shares, etc.). For EMI share schemes operated through an EBT, shares acquired by employees via EMI options have their own income tax and CGT treatment. Where the s86 qualifying conditions are not met, the exit charge applies at a rate based on the 10-year periodic charge formula — which can be significant for a large trust holding valuable business assets.
Frequently Asked Questions
Can a sole trader or partnership use an EBT for IHT planning?
No — section 86 IHTA 1984 is specifically limited to trusts whose beneficiaries are employees of a company. The employees must be employed by (or hold office with) a company — a sole trader or LLP does not qualify. However, a sole trader or partnership could incorporate (form a company), contribute assets to the company, and then set up an EBT for the company's employees — achieving the same result via the corporate structure. For business owners considering IHT planning through an EBT, incorporation is typically a prerequisite if they are not already operating as a company.
What is the difference between an EBT and an EOT for IHT purposes?
An EOT (Employee Ownership Trust) is a specific form of EBT introduced by FA 2014 that qualifies for the s86 IHT exemption and for a special CGT exemption on the sale of shares to the EOT. An EBT is the broader category — any discretionary trust set up for the benefit of employees. All EOTs are EBTs; not all EBTs are EOTs. For IHT: both qualify for the s86 exemption if the trust deed meets the broad employee beneficiary class test. For CGT: only an EOT qualifies for the vendor CGT exemption — a standard EBT does not (the vendor pays CGT on the sale of shares to the EBT in the normal way). For income tax on bonuses: only an EOT qualifies for the annual £3,600 per employee tax-free bonus.
Does the s86 IHT exemption protect EBT assets from the 10-year periodic charge?
Yes — a qualifying s86 trust is not subject to the relevant property IHT regime. This means: (1) no initial chargeable lifetime transfer when assets are settled into the EBT (no 20% IHT); (2) no 10-year periodic charge (which can be up to 6% of the trust's net value every 10 years for a standard discretionary trust); (3) no exit charge when assets are distributed to qualifying beneficiaries. For a business owner with a valuable company, this represents a significant saving: settling shares worth £5m into a qualifying EBT attracts no IHT; holding those shares in a standard discretionary trust for 10 years would produce a periodic charge of up to £300,000 (6% × £5m).
What happens to an EBT after the company is wound up or sold?
Where a company is sold (e.g. trade sale) or wound up, the EBT may hold shares or cash proceeds. The treatment depends on the structure: (1) If the EBT holds shares and the company is sold, the EBT receives cash proceeds. The EBT trustee must distribute these to qualifying beneficiaries under the trust deed — which for a qualifying s86 trust means the employees (or former employees) and their dependants. (2) Where there are no remaining employees (because the company has been wound up or the workforce transferred), the trust may become a 'bare' trust or require an application to cy-pres or variation. (3) For an EOT, the controlling interest requirement must be maintained — selling the shares out of the EOT and distributing the proceeds to employees is the typical exit route, with any residual funds going to charity or former employees. Specialist trustee advice is essential on a company sale involving an EBT.
Can a business owner use an EBT to remove the business from their estate for IHT?
Yes — in principle. Transferring shares to a qualifying s86 EBT removes the shares from the business owner's estate for IHT (the transfer is exempt under s86, no PET or CLT). However: (1) the business owner must genuinely transfer control — retaining a right to benefit from the trust as a discretionary beneficiary is possible (as an employee or former employee) but the trust must genuinely be for the broad class of employees, not structured as a retained control mechanism; (2) the business owner cannot retain voting control in a way that effectively means the shares have not been transferred; (3) if HMRC treat the EBT as not genuinely qualifying (because in practice only the owner benefits), the transfer may be treated as a CLT or GWR situation. An EOT structure (with the required equality provisions and employee control) provides the strongest protection against HMRC challenge.
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