Employee Ownership Trust

Employee Share Ownership Trusts (“EOTs”) are being increasingly used by the owners of a business to create a sale which is 100% free of Capital Gains Tax (“CGT”) and approved by HMRC.

In these unprecedented times there has been an increasing number of shareholders who wish to sell their companies or individual shareholdings and the EOT is a very attractive proposition in these uncertain times.

If you are thinking about putting your business up for sale or succession planning, you should consider if an EOT may offer you a different and tax efficient pathway.  You should investigate if an EOT may be the right choice for your business and employees.

What is an Employee Ownership Trust?

An Employee Ownership Trust is a type of Employee Benefit Trust established for all employees of the company.  It is the ‘vehicle’ used to acquire a controlling interest (of more than 50%) in a trading company from its business owners.

When to consider an EOT for your business?

This structure would typically be used when a shareholder leaving the business does not want to sell to a third party and instead would like to reward the existing employees by enabling them to indirectly own the business that they have helped to build whilst engaging and motivating them to take the business to the next level.

Conditions and rules for setting up an Employee Ownership Trust

There are a number of conditions to establish an EOT that will require careful consideration by business owners in consultation with their staff.  These include:

• The EOT must operate for the benefit of ‘all employees’ ‘on the same terms’ – this does not mean that some employees can be more senior and paid more than others. What it does mean is that they are all beneficiaries under the trust.
• The company must be a trading company or part of a trading group – HMRC has definitions of what trading means. The intention is to rule out investment companies.
• The EOT must acquire a controlling interest in the trading company (more than 50%).
• The number continuing shareholders who are directors/employees must not exceed 40% of the total number of employees in the company – this means very small companies may not qualify.

Other practical considerations when setting up an Employee Ownership Trust

These include :

• who to appoint as a trustee of the EOT; (typically, a UK resident company is used);

• the governance structure between the company and the trustee of an EOT;

• the market value of the controlling interest sold to the trustee; (which will require an independent valuation); and

• how the trustee will fund the purchase of a controlling interest; (typically, the majority of the purchase price will be left outstanding, as a loan owed to the business owners who are selling shares, which will be repaid over time out of the profits of the trading company (this is known as vendor loan financing)).

Business owners have a fair degree of flexibility in structuring a move to an EOT.

In addition, EOTs may if they wish pay income tax-free bonuses of up to £3,600 per employee each year, although there is no exemption for national insurance contributions, if tax free bonuses are paid.

What are the advantages of an Employee Ownership Trust?

Some of the main advantages and benefits include :

• Employee Ownership Trusts are very attractive not least because a sale to an EOT provides many of the benefits a seller could receive through a third party sale but there are incremental benefits, less disruption and confidentiality.
• The tax break for the sellers are substantial if the tests are met – the shares can be sold at full market value without the sellers incurring any liability for CGT).
• It is possible to seek advance clearance from HMRC as to the tax position on sale of the business for certainty. If certain conditions are satisfied, the sale of a controlling interest in shares to the EOT should be free of capital gains tax (CGT). 
• Employee ownership Trusts provide a way to change a business’s ownership, but without the uncertainties inherent on a trade sale or other third party exit.  Founders who sell to an EOT remain fully engaged in the business after transition to EOT status.

It is also widely viewed that businesses and their employees  collectively benefit from EOT in terms of engagement and performance.

What are the possible disadvantages or risks?

The main disadvantages include : 

• Disqualifying events – If a ‘disqualifying event’ occurs in the tax year of the EOT’s acquisition of shares or the tax year following, the selling business owners would not be eligible to claim CGT relief (or relief would be ‘clawed back’ if the business owner had already claimed relief). Disqualifying events could be the company ceasing to be a trading company, or the EOT ceasing to meet certain requirements.
• Stamp Duty – Stamp duty will be payable on the consideration payable for the shares.  This will usually be an expense met by the trustee.
• Sale of the Company – If there is a sale of the company before the end of the tax year following the sale of shares by the business owners, the CGT that would otherwise have been due on sale by the business owners will come back into charge.  In contrast if there is a sale after this period has expired, it will be the trustees of the EOT that will bear CGT on a disqualifying event.  Care would need to be exercised at both board and trustee level as to acceptance of a third party offer, aside from tax considerations, including if a sale would be in the interests of the EOT beneficiaries.
• Market value – The EOT does have duties which would prevent it from agreeing to pay more than the commercial market value.  The usual way to fix market value is to consider EBITDA.  Businesses can be gifted to EOTs for no consideration if that is intended.

Tax clearance for an Employee Ownership Trust

A tax clearance should be sought by the company/selling shareholders in advance of sale to an EOT. This would be to ensure that HMRC would not counteract the CGT relief and treat the business owners as receiving an income tax advantage by selling their shares to the EOT.  This clearance should be applied for early in the process of transitioning to EOT status.

Advice on setting up an EOT

We specialise in all types of employee incentives. Not only do we have yeras of legal experience, we are also experts on the tax aspects. We provide bespoke advice for both employers and employees, always focusing on your objectives and circumstances in a highly practical and cost effective way.

Please do get in contact to discuss.