What is an employee ownership trust (EOT)?
Employee Ownership Trusts (EOTs) were introduced by the Government in 2014 to provide a tax-efficient structure for the sale of a controlling interest in a trading company to its employees.
The flexibility and tax advantages of EOTs have helped them gain traction as an exit strategy in recent years, especially given the current economic outlook.
Using EOTs for succession planning can allow a business owner to pass on the company to its employees for full market value without incurring a CGT charge. This method of sale can provide an alternative to external sales, management buy-outs, or private equity-backed buy-outs.
An EOT option is certainly worth considering for a private company owner wishing to retire and looking for an alternative to a trade sale. It places the business in the hands of the people who understand it, have a strong personal commitment to its long-term success and are motivated by their ownership to make it prosper.
The advantages of using a qualifying EOT for succession planning are as follows:
- an immediate purchaser for the trading company
- no capital gains tax on the vendors
- enables succession in family companies where nobody in the family wants to continue the business
- encourages employees to take a more active and constructive interest in the business
- flexibility for current shareholders to sell all or some of their shares (subject to limits required by the controlling interest and limited participation requirements)
- current owners can remain as directors and receive market-rate remuneration
- companies owned by EOTs can pay tax-free bonuses to their employees of up to £3,600, although NIC still remains payable
An EOT awards recognition for the contribution of a workforce yet maintains the culture and legacy already created. In turn, the business will find an increase in employee retention, and employment opportunities will be more attractive. Although the employee structure and day-to-day operations remain the same, the EOT gives employees the ability to contribute to business decisions.
Many family-owned or SME businesses do not have a succession plan in place so opting for an EOT removes any pressures should an illness or financial problem occur and in the future should the business choose to grow the process is proved to be more efficient with lower costs.
How can an EOT be structured?
- Tradeco makes a contribution to EOT, alternatively, EOT could borrow from a third-party lender.
- The vendor receives initial day 1 cash and/or deferred consideration for the share purchase.
- The vendor sells a minimum of 51% of the equity in Tradeco.
- Employees may receive a tax-free bonus of up to £3,600 per year.
- Key employees may be offered share options or equity as a wider/specific incentivization package.
Key Benefits
EOT Conditions
- the business must be a trading company or the holding company of a trading group
- the trustees must retain a controlling interest in the business on an ongoing basis
- the number of continuing shareholders who are directors or employees (and people connected with them) must not exceed 40% of the total number of employees of the company or group.
- the settled property (the shares) must be applied for the benefit of all eligible employees on the same terms (but may distinguish the application of benefits based on length of service, working hours, and remuneration)
HMRC Consultation on EOTs
HMRC opened a consultation period from 18 July 2023 for 10 weeks providing the opportunity for input and comments on the proposed reforms;
- proposal to ensure that the tax reliefs associated with EOTs meet the underlying objectives of the policy,
- proposal to reform the Inheritance Tax for EOTs
The aim behind the proposals is to ensure that the focus remains on the targeted objectives of an EOT, in terms of rewarding employees and encouraging while preventing the misuse of tax advantages for unintended purposes.
The types of proposals consulted on include:
- Prohibiting former company owners and connected persons from retaining control post-sale and requirements for the EOT trustee board to include employees or independent persons
- To prevent establishing a qualifying EOT that is non-UK resident for tax purposes, whilst still allowing scope within the EOT rules to appoint non-UK resident trustees (alongside UK resident trustees) if in particular cases this would be beneficial to the company.
- Limiting the number of employees connected to ‘participators’ (those owning or entitled to more than 5% of the company's share capital) to 25%
- To ease the EOT bonus rules, allowing tax-free bonuses to be awarded to employees without necessarily including directors.
- Many EOT transactions involve deferred payment terms from the sold company to the EOT. The proposed amendment seeks to treat these payments as non-taxable dividends as long as the price the EOT agreed to pay for the company was not more than its market value. This change addresses concerns about relying on concessional tax reliefs from HMRC which can be withdrawn at any time.
Other considerations
- Increasing the £3,600 limit on tax-free bonuses to take into account economic changes since 2014
- Permit additional criteria for the allocation of bonuses, such as job role or level
The outcome of the consultation is still pending however with the newly appointed Labour government we expect further limitations but for EOTs to continue to be widely supported.
An incorrectly structured sale to an EOT can have adverse and unexpected tax consequences, therefore it is important to seek professional advice from an advisor with previous experience setting up EOTs before proceeding.
At Pierce we have experience implementing a sale to an Employee Ownership Trust, please do not hesitate to contact the Pierce Corporate Finance Team or Tax Director Dominic Ball on 01254 688100.