Employee Benefit Trusts (EBTs) are now a common phenomenon for larger listed companies and for good reason. They provide an effective mechanism for delivering employee share incentive arrangements that align employee and shareholder interests as well as an effective way to deliver financial benefits to employees more broadly.
But EBTs are not without their challenges. Following widespread use in the early 2000s within tax avoidance structures, they are now heavily restricted and regulated by some of the most complex anti-avoidance legislation including Part 7A of ITEPA 2003, the 2019 Loan Charge and the General Anti-Abuse Rule. Investor focus on executive remuneration, heightened regulatory scrutiny and increasing use of sophisticated share-based incentive arrangements have placed EBT accounting under greater attention than ever.
As companies seek to align remuneration with long-term value creation, finance teams must ensure that the accounting outcomes faithfully reflect the economic substance of these arrangements. As a result, despite their usefulness they also present technical challenges under IFRS. Getting the accounting wrong can have serious consequences for listed companies.
What are EBTs?
In a nutshell, an EBT is a legal entity established to hold assets – usually the shares of the sponsoring company – for the benefit of the employees such as, share option schemes; restricted share plans; performance share plans; deferred bonus plans; and employee share ownership plans.
While managed by the trustee, they are usually funded by the sponsoring company by cash or share contribution. Those shares are held until vesting conditions are met, at which time they are transferred to employees.
Why EBTs matter
EBTs are strategically important for a number of reasons. Beyond their principal use as an important tool for rewarding employees’ focus on increasing shareholder value with equity-based compensation, EBTs can control dilution of equity by buying shares in the market and deliver on earnings per share (EPS) targets; as well as increasing liquidity and to some extent, stabilising the share price.
IFRS Framework for EBT Accounting
The key standards that relate to EBTs are:
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IAS 32 – Financial Instruments: Presentation, this indicates how to handle Own Shares.
IFRS 2 – Share based Payment, this sets out how to measure and report employee awards.
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Common accounting pitfalls and how to address them
1. Not consolidating a trust where control exists
This is one of the most frequent errors. Although many listed company EBTs meet the IFRS 10 control criteria and are therefore consolidated, preparers sometimes assume that the legal separation of the trust automatically means it should remain outside the group. However, legal form alone is not determinative. A detailed assessment of control, exposure to variable returns and the ability to affect those returns is required. Control is defined by:
- having power over relevant activities of the EBT;
- being subject to variable returns from those activities, e.g., employee services; and
- having power to affect those returns.
While the trustees act independently, they do so within guidelines set by the sponsoring company. Since the aim is to assist with the sponsoring company’s reward policy, it almost always has control.
Most companies do not consolidate their EBT due to the mistaken belief that since there is a legal separation, then it automatically follows that the trust is separate for accounting purposes, without taking into account accounting principles that call for the consolidation of trusts in case a company controls the trust, has an exposure to risks in the trust or enjoys most of the benefits of the trust. To avoid this pitfall, account preparers must undertake a thorough control analysis according to the relevant accounting standards (e.g., UK-adopted IAS), regularly review trust governance and funding arrangements, and involve finance, legal and external auditors early to ensure that any EBT meeting the control criteria is identified and consolidated appropriately.
Failing to consolidate an EBT where control exists may result in material misstatements in assets, liabilities, equity, earnings per share and related disclosures.
2. Incorrect accounting of EBT held shares
Shares held by an EBT are often misclassified in the company’s accounts which poses a risk of misstatement of assets and failure to report treasury shares. A commonly observed accounting treatment for EBT shares is to classify them as ordinary investments or include them in issued share capital and EPS. The relevant accounting guidance, however, generally considers these shares to be treasury share equivalents, which are presented as a deduction from equity.
This can be avoided by adopting appropriate accounting policies for employee share schemes and by maintaining proper communication between HR, the finance department and trust administrators as well as conducting periodic reviews of EBT transactions to confirm that these shares of trust are appropriately shown in equity, EPS and related disclosures. Account preparers should take care to ensure that IAS 32 is rigorously applied.
3. Mixing funding of EBT with expense under IFRS 2
It is sometimes considered that the funding of an EBT is relevant to the P&L, but if the company provides funding for a consolidated EBT, it is eliminated and should not appear on the consolidated accounts. Where a consolidated EBT is funded through external borrowing, the borrowing and associated finance costs are reflected in the group’s consolidated financial statements. Companies sometimes confuse EBT funding with IFRS 2 expenses because they tend to wrongly assume that cash payments made into the EBT automatically mean that such cash payments constitute the share-based payment expense, although in principle EBT funding is always an equity item and the IFRS 2 expense has to be calculated separately taking into account the fair value of the award, which has to be recognised over time. To avoid this, companies should maintain a proper segregation between trust funding activities and IFRS 2 accounting, and ensure that proper reconciliations and technical accounting reviews take place for all employee share schemes.
Getting this wrong risks double counting of costs.
4. Errors in diluted earnings per share (EPS) modelling
The calculation of diluted EPS can be particularly challenging where share awards have complex vesting conditions or market-based performance targets. In practice, issues can arise when the impact of EBT-held shares and potential share awards is not fully reflected in the weighted average number of shares or when the treasury stock method is applied incorrectly. This can result in dilution being misstated. To reduce this risk, companies should maintain robust EPS models, regularly reconcile movements in EBT-held shares, and perform technical reviews to confirm compliance with the diluted EPS requirements of IAS 33. Consistency in the assumptions and scenarios used within EPS models is also important.
5. Insufficient disclosures
Some firms’ disclosures may lack information regarding their trust’s structure. As a result, there is a risk of challenge from regulators and reduced transparency for investors.
Inadequate EBT disclosures by companies stem from underestimating the level of transparency required regarding the trust’s structure, its funding, shareholdings, related party matters, and the effect on the financial statements, which makes it difficult for users to understand the economic nature of the transaction; to avoid this pitfall, entities need to conduct a thorough disclosure assessment in line with the relevant accounting standard (IFRS/UK-adopted IAS), maintain close coordination between finance, legal and share plans departments, and use leading practice for benchmarking disclosures.
Account preparers must provide narrative disclosures that discuss purpose, activity, and their impact on the financials. In particular, a listed company must provide adequate and clear disclosures on:
- the nature and reason for the EBT;
- the number of shares held and changes during the year;
- share-based payment schemes; and
- the impact on equity, results, and EPS.
Conclusion
EBTs are a key component for providing equity-based remuneration to employees in publicly traded corporations.
Under IFRS rules, the financial reporting for EBTs is based on three main principles:
- EBTs are consolidated under IFRS 10;
- Shares held in EBTs are recorded as treasury shares under IAS 32; and
- Employees’ awards are recorded under IFRS 2 at fair value.
If these principles are consistently applied, avoiding common pitfalls, transparent and accurate financial reporting is possible for firms using EBTs.
As employee share ownership and equity-based incentive arrangements continue to grow in importance, the accounting implications of EBTs are becoming increasingly significant. Getting the accounting right requires careful consideration of IFRS 10, IAS 32, IFRS 2 and IAS 33, together with robust governance and reporting processes.
Organisations should periodically reassess their trust arrangements to ensure that accounting treatments remain appropriate as schemes evolve.
If you would like to discuss the accounting, governance or reporting implications of an Employee Benefit Trust, please contact Nicholas Joel or Elorm Numadzi.
