The advantages of Employee Benefit Trusts

Hong Kong has long attracted the brightest and the best to work in one of the world’s leading international financial centres, which also happens to be a Special Administrative Region (SAR) of China, the world’s fastest-growing major economy. But while Hong Kong has always been forward thinking in its approach to capital, it has generally been less dynamic in its approach to human capital.

That is now changing. The traditional ‘base plus bonus’ formula for remuneration in Hong Kong is increasingly being supplanted by more progressive packages that include occupational pension schemes and employee benefit trusts (EBTs) that assist employers to attract, retain and reward key talent in the face of ever greater international competition.

Whilst an occupational pension scheme requires the company to apply additional funding to the individuals’ remuneration, some companies wish to incentivise and reward employees through types of share option plans. By aligning the interests of employees with those of the shareholders, such plans encourage loyalty and commitment on the part of the employees and a desire to see the company perform well. Companies benefit from dedicated and motivated employees, who in turn can expect greater rewards from the successes of their employer.

Such plans include employee share option plans (ESOPs), through which employees are granted a right to purchase a defined number of shares at a fixed price on a specified date or during a time window in the future, or restricted share plans (RSPs), through which shares are awarded to an employee at a discount or for zero consideration but typically include a vesting period and, in some cases, performance conditions.

The choice of employee incentive plan will largely be driven by an employer’s objectives and business plans, as well as the existing and anticipated share structure of the company, the number of intended beneficiaries and any relevant legal and tax issues.

Using the company’s shares as an incentive means that there is no need for an instant cash settlement and, in future years, settlements can generally be made from surplus profits. Where an employer wishes to use its shares, with or without an additional cash settlement, they can create an EBT.

Under an EBT arrangement, an employee is typically required to remain as an employee of the company for a prescribed period of time before the benefits vest with them. At this point, they can either hold the shares and receive any dividends that are paid, or they can sell the shares back to the company for a prescribed sum.

The trustee would generally be guided by the recommendations of the plan committee of the company in respect of which employees, or groups of employees, are to benefit and when – vesting conditions are typically based on criteria such as performance milestones or specific vesting schedules. It will generally have wide powers under the trust deed in respect of the trust’s operation and administration, including the type of awards to be delivered to the employees – in the form of shares or, if the company has liquidity, cash from the sale of shares.

Not all EBTs hold shares in the company as an asset. A common variant involves bonus payments earned by employees. Instead of being paid directly to the employee, these can be deferred and settled on the EBT to vest as and when the employee has completed a prescribed period of continuous employment with the company.

The advantages of using an EBT are that assets held in an EBT are not available to creditors should the company go into bankruptcy and any potential conflicts of interest can also be avoided because the trustees are required to act in the interests of the beneficiaries. In the case of private companies, an EBT can also be used to create an internal market in shares.

The tax treatment of EBTs, including contributions to and benefits received from, can vary so it is essential to take detailed tax advice from the outset to ensure that the arrangements meet the company’s objectives and any tax implications – both for the company and the employee beneficiaries – are clearly understood. Where a company has a mobile workforce, local tax legislation and an employee’s personal circumstances will also need to be considered separately. Tax legislation can change, so it is important that tax advice is taken an ongoing basis.

Sovereign has seen an increase in the use of employee incentive schemes in Asia over recent years across a wide range of businesses – from start-ups to listed companies – and across a wide range of industry sectors, from traditional supply chain companies to Fintech and Biotech. Given the need to attract, incentivise and retain high calibre employees in these markets, we would expect EBTs to become an ever more significant tool.

Sovereign Trust (Hong Kong) is highly experienced in consulting on and setting up structures to assist clients to maximise the value of their employee incentive propositions. We also provide specialist trustee and administration services in respect of EBTs to ensure that such arrangements continue to meet the needs of employers and the interests of the beneficiaries. Our consultants would be delighted to meet with you and discuss if and how an employee incentive scheme might be of benefit to your business.

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