For years, there has been debate over whether the noble aspirations of the Employee Ownership Trust (EOT) tax provisions were being abused. On 30 October, the Budget Notes provided clarity on HMRC’s stance, although subject to the final legal drafting and Royal assent. The changes are mostly good news for those using EOTs within the original spirit of the law. However, they are less favourable for those intending to use EOTs with tax avoidance in mind.
What is an EOT?
The premise of the EOT legislation is to encourage a much wider participation in the ownership of an established and/or entrepreneurial company.
Could EOT work for your business?
- Do you have a cohort of reliable, established employees who share a vision for the company?
- Do you believe the employees might be interested in being beneficiaries of a Trust that owns the company?
- Would that interest be piqued if they could utilise future profits of the company to pay for the purchase of the company?
If the answers are yes, then utilising EOT could be well aligned for you.
How does an EOT work?
Here is a simplified breakdown:
- You will agree on the value of the shares you wish to sell with the Trustees of a newly established EOT. Post-Budget, this value must now meet specific market valuation requirements.
- To transfer control of the company to an EOT, you must sell at least 50% of the company’s total shares to the EOT. Once this is done, the Trustees of the EOT will manage and own the company on behalf of the employees.
- The agreed sale price can be paid using initial (typically current balance sheet cash) and deferred arrangements (typically over two to four years), the latter out of the accumulating profits of the company.
- Employees will nominate representatives to sit on the board of the corporate trustee, having a direct say in how the company evolves and develops at the highest level.
- The current owners can remain in the structure, although not as controlling owners.
The essential drivers to EOT are to promote the company's commercial success, employee wellbeing and future performance. If your goals align with these principles, the EOT structure could be a great fit. HM Treasury encourages the EOT structure by offering that the seller(s) of the shares secure a zero CGT charge on the gain arising on that share sale. In the future, the beneficiaries (the employees) will share the proceeds after tax from any later sale of the company, upon instruction.
Along the way, each beneficiary can receive an annual tax-free bonus of £3,600 (subject to NIC) as a very modest “thank you”. However, it is the longer-term horizon that should be the main objective, including the beneficiaries driving the company’s future success, receiving distributions from the Trust (funded by company dividends), and ultimately benefiting from any future sale of the company shares by the trustees - see Budget updates below for further details.
What changed in the 2024 Budget?
HMRC have closed loopholes and some mischief is now blocked, if you are after the beneficial UK tax perks.
Offshore trustees banned: The Budget changes included prohibiting the use of offshore corporate trustees. There can be reasonable commercial reasons for such a structure, but there was also undoubtedly exploitation of this – this is no longer the case!
Trustee independence: There was also concern that a corporate trustee effectively controlled by the seller of the shares was just a little too cosy. As a result, it’s important to consider this when designing the trustee structure after the sale in new EOTs. Interestingly, I cannot find any comment (at the moment) on the treatment of existing EOT arrangements. Tax press suggest that older structures may be allowed to keep the old rules.
Market valuation required: Valuation has also been addressed by HMRC. Previously, the tax legislation did not prescribe the need for a market valuation, although clearly something akin to market value should be agreed – remember, the trustees must be acting in the best interest of the beneficiaries. The new rules will make this a tax requisite under the EOT provisions.
Long-term ownership mandated: Longer- term ownership by the beneficiaries (the employees), must be your objective when using the EOT provisions. The new law will likely specify that, if the trustees sell the company within four years of acquiring it, then the seller will face a clawback of the CGT that was originally extinguished in their EOT tax claim.
What should you do?
Please note that, although the postulated changes came into effect on 31 October 2024, we are at the stage of considering Budget Notes and draft legislation. Rather than taking knee-jerk action, we highly recommend that you consult with your tax adviser to understand what all of this may mean for your existing or planned employee-owned company.
The next step
If you are interested in a new EOT, or want to discuss existing structures, please contact David Jones at d.jones@uhy-rossbrooke.com, or your usual UHY tax adviser.
