14th December 2023

Employee Ownership Trusts: a win-win for owners and employees

Giorgio Pizzetti

Associate

Created by the Finance Act in 2014, Employee Ownership Trusts (EOTs) are a government initiative to encourage more companies to become employee-owned and is a model most famously employed by John Lewis.

To incentivise this shift, both the owners who relinquish control and the employees of the company are entitled to receive enhanced tax benefits. EOTs do not involve direct share ownership by employees, rather a controlling interest in the shares of the company is held by trust in which the employees are the beneficiaries.

What are the benefits an EOT?

Selling your shares to an EOT offers a range of benefits, not only to the vendor, but also to the employees and the company itself. Such benefits include, but are not limited to:

The transfer of the vendor’s shares to the EOT can be made free of capital gains tax (CGT), saving up to 20%. Additionally, a gift of shares to an EOT is an exempt transfer for inheritance tax purposes (subject to compliance with the qualifying conditions discussed below)
The employee can receive annual bonuses of up to £3,600 free of income tax
A corporation tax deduction for the value of the bonuses will be available to the company
Facilitates an exit where there is no obvious third-party purchaser and avoids the risk of a ‘hostile’ takeover
A government-sanctioned method for extracting future profits in a tax-efficient manner
Fostering greater employee commitment to the company’s success
Improved business performance, employee retention and innovation at all levels.

Qualifying conditions

In order to claim the capital gains tax relief and to pay income-free tax bonuses to employees, the transfer of the vendor's shares to the EOT must meet all of the qualifying conditions. The qualifying conditions set out various requirements that the EOT must meet immediately prior to its acquisition of the company. These requirements include, amongst others, the need for the trust assets to be available for the benefit of all eligible employees on the same terms (subject to some exclusions) and that the EOT must hold more than 50% of the company (or holding company of a trading group).

Disqualifying event

Just because the EOT has been set up, this does not mean that the vendor/EOT are in the clear of potential tax liability. To make sure they retain their tax reliefs, the EOT will need to ensure that a disqualifying event does not occur after completion. These events include, but are not limited to, the EOT any longer holding more than 50% of the share capital and the company ceasing to be a trading company or the principal (holding) company of a trading group.

If a disqualifying event occurs before the end of the tax year following the disposal, any claim by the vendors for CGT relief will be revoked. If such an event occurs after the end of the tax year following the disposal, HMRC will seek to recover the CGT from the EOT, which is treated as disposing and reacquiring the shares held by the EOT for a consideration equal to their market value at the time of the disqualifying event.

Who will run the company after the shares are sold?

The board of the trading company retains responsibility for the company’s management, and there’s no requirement to change the board composition. However, this can be an opportunity for new appointments.

As the majority shareholder of the company, the trustee(s) of the EOT will control the company at the shareholder level. Whilst nothing is preventing the appointment of individuals as trustees of the EOT, it is more common, and much more advantageous from an administrative point of view to incorporate a trustee company to act as sole trustee of the trust.

EOT valuation and funding

A sale to an EOT is considered a transaction at market value, and it is required to have an independent valuation to support the transaction. This is significant for both the vendor and the trustees, as it demonstrates that the agreed sale value aligns with a fair, arms-length negotiated transaction value.

From the vendor's perspective, this valuation is also vital for tax purposes, ensuring that the company is not overvalued and that the vendor can fully benefit from capital gains tax relief for EOT sales.

How can we help?

Hunters can assist with all aspects of implementing an EOT as follows:

We can prepare the necessary share transfer, trust deed, funding documentation and ancillaries to ensure the transfers occur in accordance with the legislation
If you are a trustee and the EOT transaction is already underway, we will be able to advise you on the transaction documents so you can be confident you are acting in accordance with your obligations
We will advise you on the operation of EOTs so that you can decide if an EOT is the best option for your company
Share valuations – we will be able to recommend advisors who will be able to provide a robust and fair valuation of the company. They will also be able to provide any advance taxation clearances
Employee communications - we will assist with the production of communications to employees to ensure that they understand and appreciate the benefits to them of the move to EOT status.

If you are interested in learning more about selling your business to an EOT, please contact Giorgio Pizzetti at giorgio.pizzetti@hunterslaw.com or Piers Larbey at piers.larbey@hunterslaw.com.