A Guide to Employee Ownership Trust Tax Benefits

Employee Ownership Trust

Employee Ownership Trusts (EOTs) were first introduced in 2014 and have increased in popularity in recent years due to their tax advantages.

Many business owners and shareholders make the decision to sell their shares to an Employee Ownership Trust, rather than enter into a conventional standard trade sale. 

What is an Employee Ownership Trust

An EOT is a special form of employee benefit trust introduced to encourage more shareholders to set up a corporate structure which facilitates wider employee ownership.

Employee ownership is where all employees have a ‘significant and meaningful’ stake in a business.

This means employees must have both:

  • a financial stake in the business (eg by owning shares)
  • a say in how it’s run, known as ‘employee engagement’

How does a sale to an EOT work?

Employee Ownership Trust

There are three key steps for business owners or shareholders to make a sale to an EOT:

  1. A qualifying EOT will be established with a trading company as the trustee of the EOT (the Trustee Company).
  2. The shareholders sell their shares to the Trustee Company under a share purchase agreement. The shareholders and the Trustee Company will jointly engage a share valuation expert to value the company. This valuation will be used as the basis for determining the purchase price. On the sale of the shares, the purchase price will create a debt owed by the Trustee Company to the shareholders which will be left outstanding.
  3. The company’s yearly trading profits will be used to make contributions to the EOT. The EOT will use these contributions to repay the outstanding purchase price that it owes to the shareholders.

Not all shareholders are required to sell their shares to the EOT and once the sale to the EOT is complete (this typically takes three to six months) it is common for the seller to remain working for the company. They will often remain as a director but frequently wind down their involvement and role within the company.  

One possible disadvantage for the seller is that they may have to wait several years before receiving the full sale proceeds. However, once the EOT has become established, it is possible to raise bank loans to pay off the previous owners completely. 

Tax Advantages of an Employee Ownership Trust

It all sounds a little complicated – so what’s the incentive for setting up an Employee Ownership Trust?

The answer is that the Government introduced very generous tax breaks to encourage shareholders to move to an employee-ownership model. Namely that no capital gains tax will be payable on the gain made when they sell their shares to an EOT.

The capital gains tax relief is given by treating the sale as a no gain/no loss disposal.

This is a massive tax break for the seller as they would normally have to pay a

20% CGT rate on the capital gain.

However, to qualify for the tax incentives, the EOT needs to be structured in a particular way.

How to qualify

In order to qualifying for the tax relief there are five key conditions

which must be met:

  1. The company whose shares are being sold to an EOT must be a trading company, or the holding company of a trading group.
  2. The trustees of the EOT must retain, on an ongoing basis, at least a 51% controlling interest in the company.
  3. The vendor selling the shares must be a UK tax resident individual, not a company nor an institution.
  4. The number of continuing shareholders (and any other 5% participators) who are employees or directors (including anyone connected with them), must not exceed 40% of the total number of employees of the company or (if applicable) the group.
  5. The EOT must be set up for the benefit of the employees on the same terms. However, the sums paid to the employees can vary according to length of service, remuneration or hours worked.

Employee Benefits

Employee Ownership Trust

The EOT will be run by its trustees, who will normally consist of: 

  • An employee representative
  • An independent professional trustee
  • The previous owner(s) (until they have received the sale proceeds in full)

Once an EOT has been set up and formed there are several ways that employees can benefit from the company being under EOT ownership:

  • Permanent employees will be entitled to a share of the profit that the company makes each year. 
  • Employee owners frequently feel greater job satisfaction and security.
  • The EOT trustees must ensure that the profits of the company are distributed to the eligible employees on the same equal terms.
  • Employees will have an increased say in the strategic company decision-making

When profits are distributed to the employees, each employee can receive a bonus of up to £3,600 income tax-free per fiscal year. (The bonus is subject to National Insurance.)

Additionally – although the tax breaks are aimed at companies, businesses held by a partnership can be incorporated so that, when the time comes for exit, the shareholders can sell their shares to an EOT.

In Conclusion

There are many benefits to an Employee Ownership Trust, for both business owners looking to sell their shares or entire businesses and employees.

Business owners can take advantage of significant tax breaks whilst employees can benefit from a share of the business profits with tax-free bonuses and greater job satisfaction and security in their role.

If you are interested in finding out more about EOT’s or have any questions please get in touch with our friendly team.

We take the jargon and ‘accountant speak’ and turn it into benefits for you and your business.

You can contact us on 01257 241111 or email info@studholme-bell.com

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