Employee Ownership Trusts (EOTs) represent a compelling strategy for business owners considering a transition to employee ownership. Recognised for fostering enhanced employee engagement and commitment, EOTs also offer significant tax advantages that can benefit both the transferring owners and the employees. Here, we outline the key tax reliefs associated with EOTs and discuss the conditions under which these benefits apply.
Understanding Employee Ownership Trusts
EOTs are designed to facilitate employee ownership of companies. They operate by holding shares in a trading company or the principal company of a trading group for the benefit of the employees. EOTs are typically discretionary, allowing trustees to decide if and when employees should receive payments or other benefits. This structure is intended as a long-term vehicle to support a company’s culture and incentivise both current and future employees.
Tax Reliefs Associated with EOTs
The transition to an EOT structure can provide substantial tax advantages:
- Capital Gains Tax (CGT) Relief:
Owners transferring shares to an EOT may claim CGT relief, meaning the transfer neither generates a capital gain nor a loss. This exemption can save sellers up to 20% in taxes, providing a tax-efficient exit strategy.
- Inheritance Tax Exemption:
Transfers to EOTs are exempt from inheritance tax, which can include significant gifts or sales at undervalue. Furthermore, EOTs are not subject to the typical inheritance tax charges that can arise every ten years in other trust arrangements.
- Income Tax Exemption for Employees:
Employees can receive bonus payments up to £3,600 annually without any income tax liability. This exemption does not extend to National Insurance contributions, which are still applicable.
- Corporation Tax Deduction:
The employing company can claim a corporation tax deduction for bonuses that qualify for the income tax exemption.
HMRC Consultation on EOTs
A consultation by HMRC on EOTs has raised several proposals that could impact how EOTs are structured and operate:
- Governance Changes: Proposals include prohibiting former owners and connected persons from retaining control post-sale, and requiring the EOT trustee board to include employees or independent persons.
- Employee Benefit Restrictions: Limiting to 25% the number of employees connected to a participator who can receive income payments.
- Bonus Rules Modification: Easing the EOT bonus rules to allow tax-free bonuses to be awarded more flexibly, potentially excluding directors from mandatory inclusion.
These consultations also explore possibilities for:
- Adjusting the criteria to reflect the need for companies to hold substantial cash reserves.
- Increasing the £3,600 limit on tax-free bonuses to reflect economic changes since 2014.
- Allowing additional criteria for bonus allocation, such as job role or level.
While the outcome of the consultation, which closed in September 2023, is pending, the changes discussed could further refine the EOT framework to support employee engagement and financial benefits. We will issue a further update when the findings are published.
Practical Considerations
Businesses contemplating the transition to an EOT should also consider several practical aspects:
- Funding the EOT: Typically, the EOT is funded through profits of the company, which may affect cash flow and the total amount receivable by the seller.
- Tax Clearances and Governance: Obtaining HMRC clearances and establishing robust governance structures are critical for ensuring the EOT operates effectively and complies with regulatory requirements.
- Employee Communication: Effectively communicating the benefits and changes associated with EOTs is essential for maximising employee buy-in and participation.
Conclusion
EOTs offer a unique opportunity to transform business ownership in a way that benefits both owners and employees through significant tax advantages and enhanced engagement. For those considering this transition, early consultation with tax experts and careful planning are essential.
For more detailed guidance on setting up an EOT or understanding its implications for your business, contact your Beavis Morgan partner or reach out to us directly atinfo@beavismorgan.com.
Disclaimer: This note reflects the law in force as at May 2024. Please be aware that it does not cover all aspects of this subject. To find out more about any aspect of the above, please discuss with your usual Beavis Morgan contact.
For comprehensive advice, please consult with a professional.