The use of Employee Ownership Trusts (EOT) by private companies has increased in popularity, but are they right for your company?
Craig Simpson, Tax Partner at Bates Weston considers the issues involved.
The concept of an EOT is not new and was introduced in tax statute in 2014 following the earlier Nuttall review in 2012. The government were seeking to capture the significant benefits of employee ownership that larger businesses adopting shared ownership had achieved. A well-run employee owned company could benefit from a longer term business strategy and not have to consider the conventional exit routes, with the EOT giving an alternative succession route. In turn, a more engaged and happier work force could lead to higher profits. There are certainly many benefits from employee ownership.
Employee ownership is not for every company though and it is probably why the uptake in private companies has been slow. But for many companies, where a conventional exit is not possible, using an EOT has significant tax breaks. The legislation is a very good example of how the tax law can be used to influence behaviours.
Broadly the following tax reliefs apply:
- There is no capital gains tax for selling a controlling interest to an EOT (i.e. 51%+)
- EOT’s can pay tax-free bonuses up to £3,600 per year to employees;
There is a whole raft of legislation which is beyond the scope of this brief article but great care needs to be taken on implementing an EOT and also ensuring that the tax free status of the share sale is maintained as there are disqualifying events which can lead to the capital gains tax charge being triggered.
Whilst the tax breaks are clearly very favourable it is important to consider first and foremost whether an EOT is the right cultural fit for the business longer term and not just a route to sell a controlling interest with no tax.
On a sale, the proceeds are often funded by the company from surplus cash and future profits. The shareholders could sell 100% of the company or have a hybrid scenario where they sell a controlling interest and retain shares.
So overall using Employee Ownership Trusts is certainly worthy of consideration for the right type of business, but what are the potential tax pitfalls and general issues to consider?
- The tax-free nature of the sale funded by the company is an attractive proposition but could lead to the focus being on the objective of extracting value free of tax rather than genuine promotion of employee ownership culture for the longer term.
- If HMRC were to consider tax avoidance was the motive they have transactions in securities anti-avoidance in their armoury which could turn the nil gain into a dividend. A clearance under these rules is important.
- Careful attention needs to be given to valuation of the shares. If the shares are over-valued then the employment related securities rules could apply seek to apply an income tax charge on selling shares at an over value,
- The long-term implications of having a controlling interest in an employee trust need to be properly thought through. If the company is sold in the future what would this mean?
- There will be costs of running the EOT and careful attention to governance.
- In the transition to employee ownership you would expect to see a significant amount of communication and work on the change to an employee-controlled culture.
EOT’s certainly have their place in modernising business structures and opening minds to the idea of succession through employee ownership and all the benefits it can bring. In doing so it is important that the focus is not just extracting value free of tax, otherwise HMRC will rightly scrutinise the rise in popularity of EOT for any abuse of the rules.
Disclaimer: The information contained in this article is generic in nature. You should take no action based upon it without consulting ourselves or an alternative professional advisor. All information correct at time of publication: 11 October 2021.