Are EOTs as we know them here to stay?
Reforms for Employee Ownership Trusts
Employee Ownership Trusts (EOTs) were introduced by the government back in 2014 and we have seen that there has been increased appetite for EOTs amongst business owners however, there is also a backdrop of increased controversy relating to their use.
EOTs are available for new businesses but can be especially attractive if you wish to sell your established business to realise the value in it in a tax efficient manner (and crucially free of Capital Gains Tax (CGT)) whilst achieving employee ownership of the business and thereby incentivising your employees and securing the long-term future success of the business through employee ownership.
They are particularly useful for owners of owner managed businesses or family businesses that are thinking about retirement or succession. They can complement a future planned management buy-out allowing for a partial sale to management alongside a partial sale to an EOT whilst facilitating a smooth transition to a full buy-out over time. They also offer an alternative to a traditional trade sale.
On 18 July 2023, HMRC published an open consultation on Taxation of Employee Ownership Trusts and Employee Benefit Trusts which is open until 25 September 2023.
The consultation is looking at Employee Benefit Trusts (EBTs) generally but a main aim of the consultation is to specifically make sure that EOTs (which are a type of EBT) are focused on rewarding and motivating employees through share ownership/benefits rather than being used purely as tax saving mechanisms.
What are EOTs?
EOTs are a specific type of EBT, through which a business will become employee owned. EOTs are a vehicle that a company establishes which purchases a controlling interest in the company and holds it on behalf of the company’s employees as a whole (benefiting the employees through distributions, bonuses and ultimately on a future exit). This means the current business owners can retain some shares in the business.
Benefits of EOTs
EOTs benefit from very generous tax reliefs (provided certain conditions are met).
The three tax reliefs available for an EOT are:
- 100% CGT relief when you transfer your shares in your business into the EOT;
- There is no Inheritance Tax charge on certain transfers into and from EOTs; and
- Relief from Income Tax is also available on qualifying bonuses of up to £3,600 per year per employee of EOT-owned companies.
There are various conditions to qualify as an EOT and for the CGT and other tax reliefs to apply which you would need to take legal and tax advice on before implementing an EOT structure.
Government concerns and proposed changes to EOTs
The government’s main concerns appear to be:-
- The selling former business owners retaining control
In many cases EOTs will benefit greatly from the expertise of the former owners being trustees of the EOT as they often have invaluable knowledge and experience relating to the operation of the business.
However, because EOT sale structures often involve a large amount of deferred consideration to be paid to the former business owners over time following the sale and this cannot be secured in favour of the selling business owners, they often they seek to protect their interests by retaining certain controls.
Protection for the sellers in relation to their deferred consideration can be achieved in various ways (e.g. vetos over certain key matters being given to the sellers) and it is inevitability a balancing act.
Where the former owners retain control of the company through majority control of the EOT trust board, there is a question as to whether there will be enough meaningful change for the employees and whether such a structure is compatible with true employee ownership.
Similarly, there is concern that the former owners are using corporate trustees of the EOT to effectively act on their behalf and to implement their wishes relating to the operation and control of the business following the sale.
There is concern from the government that these approaches allow the sellers to obtain tax advantages whilst keeping control over the company and essentially continuing business as usual as if the sale to the EOT had not occurred.
In order to curtail the above, HMRC are proposing in the consultation that former owners should be prevented from retaining control by requiring that more than 50% of the trustees of an EOT be individuals who are not the former owners or persons connected to the former owners.
- Trustee Tax Residency:
HMRC are also proposing a requirement that trustees of an EOT be UK resident (or as an alternative, that at least some of them are) and also that the former owner of the business was UK resident at the date the shares are disposed of to the EOT which are measures designed to ensure that the EOT cannot be set up to avoid CGT by utilising residency based tax planning.
A breach of any new conditions that are brought in, such as the above, are likely to result in the loss of the tax reliefs and benefits of an EIT including the CGT relief.
EOTs have and continue to be an effective tool for succession planning and securing the future success of businesses. It remains to be seen what changes are implemented in relation to EOTs following the consultation and whether any changes will reduce the popularity of EOTs overall and/or encourage their use where there is a desire for a business to be truly employee owned.
The best solutions for you and your business will depend on multiple considerations (including whether employee ownership would be suitable and how that would operate in practice following the sale as well as tax considerations and the borrowing and financial position of the business).
Setting up an EOT will be a significant project for your business in respect of which you will need expert legal and financial advice. Typically the process takes the same sort of time a third party sale does and clearance is required from HMRC as part of the process. However, given the EOT is established by the business it can often be a more cost effective transaction from the perspective of professional costs then dealing with a third party buyer even though the trustees, business and employees may require separate legal advice.
We can guide you seamlessly through the legal aspects of the process including preparing the necessary documentation such as the EOT trust deed and the share purchase agreement relating to the sale of the shares to the EOT.
Please contact a member of our corporate team on 0161 832 3434 if you would like to discuss your exit and succession options or whether an EOT could be a suitable structure for your business.