- How Employee Ownership Trusts can benefit your business
How Employee Ownership Trusts can benefit your business
How Employee Ownership Trusts can benefit your business4th December 2020 - Published by Kuits corporate team
As we await the seemingly inevitable increases to capital gains tax (CGT) and the rumoured abolition of business asset disposal relief, formerly entrepreneurs’ relief, that the Chancellor’s next budget will likely usher in, it is a particularly opportune time to consider whether introducing an Employee-Ownership Trust (EOT) could be the right way forward for your business.
What is an Employee-Ownership Trust?
EOTs were introduced by the government back in 2014 and there is expected to be increased appetite for EOTs amongst business owners if CGT increases in the coming months, as widely anticipated.
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 CGT, whilst also incentivising your employees and securing the long-term future success of the business. They are particularly useful for owners of owner managed businesses or family businesses that are thinking about retirement or succession.
EOTs can also 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 which may be both difficult to achieve, especially in the current uncertain post-COVID economic climate where M&A activity is still relatively slow, and less appealing after the next budget, when increased CGT charges will likely go hand in hand with a trade sale.
An EOT is a vehicle that the business establishes which purchases a controlling interest in a company and holds it on behalf of the employees as a whole benefiting the employees through distributions, bonuses and ultimately on a future exit. This means you can retain some shares in the business.
EOTs benefit from very generous tax reliefs provided various conditions are met.
What tax reliefs are available?
The three tax reliefs available for an EOT are:
- CGT relief when you transfer your shares in your business into the EOT;
- An exemption from income tax on bonus payments of up to £3,600 per year paid to employees by companies owned by EOTs; and
- Relief from inheritance tax on certain transfers into and from EOTs.
The conditions to qualify as an EOT and for the associated tax reliefs are numerous and include, amongst other things, that:
- The company must be a trading company or the principal company of a trading group;
- The property in the EOT is to be held for the benefit of the eligible employees;
- Any distribution from the EOT fund, or payment under a bonus scheme that qualifies for relief, must be for the benefit of all eligible employees on the same terms, which does not necessarily mean that all employees get equal amounts;
- Loans are not permitted to be made to employees by the EOT;
- The trustee(s) of an EOT must hold more than 50% of the ordinary shares and voting rights and be entitled to more than 50% of the profits and assets available on a winding up of the company.
There are also restrictions in the criteria for the CGT relief preventing:
- A person claiming the relief where they, or persons connected with them, had already claimed relief in any earlier year in relation to a disposal of shares in the same company/group; and
- The relief being given to individuals who had a substantial shareholding in the company in circumstances where they, along with others, made up a significant proportion of the business’s workforce before and after the creation of the EOT.
When setting up an EOT there will be key matters to iron out from the outset to ensure that the project proceeds smoothly such as:
- Who the trustee(s) of the EOT will be;
- What is the value of the shares to be sold to the EOT and what will the purchase price be?;
- How the purchase of the shares by the EOT will be funded for example, via bank borrowings, the business’ resources or via the business owner selling the shares on deferred payment terms or in return for loan notes;
- What the governance structure of the EOT will be such as whether it will include an employee council who will represent the interests of the employees and often can appoint and remove the trustees and have input in the decision making of the trustees ensuring balanced and impartial governance.
The best solutions for you and your business in relation to these and all other considerations relating to setting up the EOT will depend on tax considerations and the borrowing and financial position of the business.
What are my next steps?
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 amount 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.
Get in touch with a corporate lawyer in Manchester
Please contact Helen Mather, Senior Associate, on 0161 838 8183 or email firstname.lastname@example.org if you would like to discuss your exit and succession options or whether an EOT could be a suitable structure for your business.