A Government consultation on the structure and taxation of Employee Ownership Trusts (EOTs) will close on 25 September. Here Ionut-Florin Tihulca explains what the Government is proposing and how it will change EOTs.
First introduced in 2014, EOTS look to promote greater employee ownership of a business. Business owners can, with attractive tax advantages, sell their business or shares in the business to a trust owned by its employees.
EOTs are growing in popularity. The Employee Ownership Association reports that almost 1,400 businesses are held via an EOT, with 332 new EOTs registered in 2022 alone.
The increased interest in EOTs is being driven by business owners looking to exit and structure their business in a more inclusive and ethical way, to incentivise and reward staff, and, of course, the attractive tax benefits.
Business owners can sell the business to an EOT whilst potentially taking advantage of exemptions in respect of capital gains and inheritance tax if all the conditions are satisfied. Not all shareholders need to sell to the EOT, with the EOT only being required to acquire and continue to hold a controlling interest in the company (more than 50% of the ordinary share capital). Those shareholders that do sell can remain employed by the business and receive remuneration. It is also seen as a more friendly and less aggressive way to sell the business.
For employees who have often been instrumental in building that business, it provides the opportunity to ‘own’ that business and to shape its future growth and direction. Employees can potentially receive a £3,600 tax-free cash bonus every year if all the necessary criteria are satisfied. It should be noted that employees do not directly ‘own’ shares in the business; a controlling interest in the company is held by an all-employee trust and held in benefit for the company’s employees.
So what is changing?
Currently, there are no clearly laid out restrictions on who can be appointed as a trustee. Business owners often appoint themselves so they continue to retain control of the company.
There is, of course, advantages to the business in being able to continue to access the expertise of its directors, but should a business owner be able to sell the business to an EOT with all the tax benefits yet retain control over that business? The Government thinks not.
The consultation proposes to restrict business owners from a controlling interest in the EOT requiring at least half of trustees to be individuals who are not owners or connected to them.
Currently, it is possible for a business owner to appoint trustees who are non-resident in the UK. There are often good reasons to do so – if a business has an international footprint it might be appropriate to have trustees that can represent those interests. Equally, a business can appoint non-UK resident EOT trustees even if there are no international interests.
A non-UK resident EOT may not, however, be liable for capital gains tax on any subsequent disposal or if the EOT were to be deemed non-qualifying.
The consultation proposes to address that by requiring an EOT to be UK resident as a single body, meaning all trustees be UK resident or if non-UK residents are trustees the owner was UK resident when the business was sold.
Tax-free bonuses for employees
The current rules surrounding the £3,600 annual bonus are complex, designed so they cannot be weighted in favour of directors or the highest paid individuals. This has in some circumstances made it difficult to award that bonus, particularly when a business has overseas subsidiaries or where employee non-executive directors exist.
The consultation proposes to make it easier to award bonuses to employees without necessarily having to include directors in that scheme. It will, the Government hopes, make the tax-free bonus a key feature and incentive for sale to an EOT.
It is not uncommon for new EOTs to have limited funds to pay upfront for the purchase of shares from the business owner. Payment is often made over an extended period of time through the profits the business makes. Such arrangements can potentially trigger tax liabilities, meaning businesses look first to seek HMRC approval. Here, the consultation proposes to confirm in legislation that such distributions will not trigger income tax liabilities.
The sale of a business to an EOT will have significant tax implications for shareholders, employees and the business. Independent tax advice should always be sought before deciding if an EOT is the best way for you to proceed and if the model you wish to adopt would qualify for the various tax reliefs.
The consultation, which closes for comments on 25 September, can be found here
Contact our Corporate & Commercial Solicitors
Bishop and Sewell can assist you with legal side of setting up an EOT. If you have any questions in this respect, please contact Ionut-Florin Tihulca who is a Solicitor in our Corporate and Commercial department.
The above is accurate as at 21 September 2023. The information above may be subject to change.
The content of this note should not be considered legal advice and each matter should be considered on a case-by-case basis.