This article is for employers and looks at the pros and cons of an Employee Empowerment Trust (EET), taxation issues, new legislation, and specific issues for employers.
The main objectives of an employee empowerment trust are to empower staff and give them a shareholding in the business of the employer.
Nature of the Employee Empowerment Trust
The EET is an inter vivos business trust, established by a deed which defines the trustees, their duties and powers, how they manage assets, and who are the beneficiaries. It is usually formed to enable staff “ownership” in the operation.
The trusts usually define various classes of employee beneficiaries who qualify according to certain formulae. For example: “’Beneficiary’ shall mean any person holding an interest in or entitled to receive a benefit under this deed, by virtue of such person being employed by ABC (the employer) in a permanent position for a minimum of at least 12 (twelve) months and specifically holding a particular defined position. Sometimes the ‘Beneficiary’ shall mean those additional beneficiaries unanimously agreed to by the donor, trustees and the beneficiaries acting jointly from time to time.”
The trust would be registered at the Office of the Master of the High Court, and upon receipt of Letters of Authority, the trustees would be empowered to act. The Trust deed may also contain provisions for the termination of employment of a staff member, and the consequences, for example:
A beneficiary can only lose their trust benefit due to dismissal, retrenchment, resignation, retirement, death or sequestration. In the event of dismissal, the Beneficiary forfeits the benefit and no payment is made by the Trust. In all other cases, the Trust must pay the beneficiary the average of the previous three (3) years’ benefits. The beneficiary shall no longer have an interest in the trust.
Advantages of a trust
1. Loans to purchase shares
The company (employer) can provide a loan to the Trust (staff) to purchase the shares in the company. However, if the employer is a private company [(Pty) Ltd.] it cannot help staff to purchase its shares in any way. Section 38 of the Companies Act prohibits this. However, Section 38 (2) provides an exception. If the shares are to be held IN TRUST for the benefit of employees, then the company may provide financial assistance for the purchase of shares.
If the employer is a CC, the Close Corporations Act (no 69 of 1984, as amended), which is more flexible, allows a CC to provide loans to purchase a member’s interest. However, the prior written consent of each member to the specific assistance is required, and the assistance must not render the CC insolvent. Recent amendments provide that an inter vivos trust may be a member of a CC, provided certain criteria are met.
An EET can thus hold shares in either a CC or a (Pty) Ltd. If financial assistance is provided, a loan account in the name of the trust, in favour of the employer, would be reflected in its books.
2. Empowerment / practical effects
The trust would hold as an asset the shareholding/interest, at cost. Qualifying employees (as defined) would benefit from capital growth and dividends declared by the business at financial year end. Employees (via elected Trustees) may be represented on the management board, and be more empowered. A provision could be included in all employment contracts.
3. Perpetual nature of EET
The member’s interest/shareholding is held by the Trust. This is not given directly to the employee. Rather, the employee has the right to receive dividends through the trust. In this way the trust has an indefinite existence and is not affected by any change in employees.
4.Lower costs and flexibility
Expenses and fees of setting up and auditing the trust can be deducted from the accrued dividends. The Trust does not necessarily need an annual audit as a company does, and legal requirements are fewer and more flexible.
5. Dividends and repayment of loan
Dividends declared and accrued to the trust could be used (after deduction of interest, if applicable) to reduce the loan. Then, dividends would accrue to beneficiaries of the trust.
The dividend portion of the trust’s income is not taxable. However interest earned is taxable at 40%. On declaration of a dividend, the company pays STC at 12.5%. The company is taxed on any interest received from the trust. The trust does not have taxable income (declared dividend) and can benefit from an interest deduction (a tax loss in the trust). However, any interest earned in the trust would be taxable.
If a business is required to comply with BEE legislation, black ownership through a trust is recognised (in the “ownership element” of the scorecard) provided that trustees have no discretion as to the identity of beneficiaries, or the portion of economic interest to which beneficiaries are entitled.
“No economy can grow by excluding any part of its people, and an economy that is not growing cannot integrate all of its citizens in a meaningful way.” South Africa’s BEE strategy document.