For many business owners, deciding how to exit a successful business means years of careful planning, to ensure the business is in the best shape so the highest price can be obtained, and a smooth and stress-free exit is achieved. Many will also want to exit in a highly tax efficient way and they may also want to reward the loyalty of employees who have helped them achieve success. Increasingly popular is the use of an Employee Ownership Trust (EOT) to help achieve this type of succession.
An EOT is a trust which is set up for the benefit of the employees or office holders of a company or group of companies. Since the introduction of the legislation in 2014, there are potentially significant tax breaks (0% capital gains tax) for owners of private company shares transferring a controlling shareholding into such a trust.
In addition, the EOT can make tax free bonus payments of up to £3,600 to qualifying employees. It is generally thought that these arrangements, whereby trustees own company shares and exercise control of the company for the benefit of all the employees, is motivational and engaging for employees and encourage them to stay with the business.
The trust will appoint several trustees whose role is to represent the interests of the employees but they are not responsible for the day to day running of the company. They will oversee the management and leadership of the business, and they can step in if management are not acting in the best interests of all employees.
To set an EOT the business will be valued for the purposes of this transaction and the EOT borrows the money from the sellers or use third party funding and these lenders will take a charge over the business assets. The majority of shares (over 51%) will be transferred into the trust. The EOT loan is repaid over time using post-tax profits made by the business. It is common for an EOT to issue shares of the business to key personnel and employees, but the EOT must remain in ownership of the majority of the shares.
Whilst not subject to widespread use, Employee Ownership Trusts (EOTs) have been the subject of an industry wide consultation because of perceived abuses and many of the considered changes outlined below are likely to be adopted. Another recent change is that where previously anyone considering the use of such a structure would apply for HMRC advance clearance, the ability to do this ceased as of 31 October 2024.
The following changes to the current rules have been proposed and as the draft legislation is debated and edited through to a final version, some finer detail may become apparent.
- Restriction of former owners, or persons connected with former owners, from retaining control of companies post-sale to an EOT by virtue of control (direct or indirect) of the EOT
- Requirement that the trustees of an EOT must be UK resident and not offshore at the time of disposal to the EOT
- Confirmation in legislation that contributions made by a company to an EOT to repay the former owners for their shares will not be charged to income tax as a distribution – a clarification of a technical ambiguity rather than a change in rules.
- An easing of the EOT income tax-free bonus provisions to allow bonuses to be awarded to employees without directors being included
- Extension of the period of time within which the relief can be withdrawn from the former owner if the EOT conditions are breached post-disposal, to the end of the fourth tax year following the tax year of disposal – this was previously one or two years depending on the broken rule in point
- Requirement that the trustees must take reasonable steps to ensure that the consideration paid to acquire the company shares does not exceed market value (an interesting point as trustees by their very nature are required to ensure they do so)
- Requirement that individuals provide within their claim for Capital Gains Tax (CGT) relief information on the sale proceeds and the number of employees of the company at the time of disposal
- Confirmation in legislation that the restrictions on connected persons benefiting from an EOT must apply for the lifetime of the trust
- Only allowing the Inheritance Tax (IHT) exemption for EOTs where the shares have been held for two years prior to settlement into the EOT
- Requirement that no more than 25% of employees who are able to receive income payments from an EOT should be connected to the participators of the company.
There is much to consider if a business owner is considering a sale via an EOT, and it isn’t suitable for a business with cash flow issues or which is in distress. With these proposed changes it is essential to take professional advice to see how your plans may be affected in the future.
Kevin Paget is a partner at Mercer & Hole www.mercerhole.co.uk
