An Employee Ownership Trust (EOT) is a vehicle which acquires shares in companies from shareholders. It enables shareholders of qualifying companies and groups to obtain full Capital Gains Tax (CGT) relief when they sell a controlling interest to an EOT. This means that an individual can sell shares to an EOT and pay zero tax!! However, the rules are complex, and careful navigation is required.
In this blog, we’ll explore:
- The key Autumn Budget 2024 updates to the EOT regime
- What these changes mean for former owners, trustees, and employees
- Common challenges when selling to an EOT
- Practical considerations for deciding if an EOT is right for your business
Recent Changes to Employee Ownership Trusts from 2024
1. Former Owners Can No Longer Control the EOT
Previously, it was possible for a former owner to effectively maintain control of the company by appointing themselves or connected persons as a majority of the trustees. This undermined the spirit of employee ownership.
From 30 October 2024:
- Former owners and connected persons cannot constitute a majority of the EOT’s trustees.
- A breach of this rule becomes a disqualifying event, triggering an immediate CGT charge.
This ensures that genuine control passes to the trust for the benefit of employees, and not just on paper, but in practice. Essentially, the majority of the trustees, or Directors if there is a corporate trustee company, must therefore be independent persons. However, it is worth noting that the former owners can still be Directors of the trading company, and be involved in the day to day management of the business.
2. New Residency Requirements for Trustees
Before the Autumn Budget of 2024, there were no rules about where the trustees were tax-resident. Some EOTs were established with non-UK resident trustees, enabling avoidance of UK CGT on future disposals. Now:
- Trustees must be UK-resident, ensuring that the trust is fully tax resident in the UK.
- If the EOT becomes non-resident later, it will face an exit charge under Capital Gains Tax rules.
3. Valuation and Interest Rate Restrictions
EOTs must now take all reasonable steps to avoid overpaying for the company shares:
- A market valuation is required before the sale. It is therefore essential that the trustees and the sellers jointly appoint an independent valuer to enable the parties to agree on the sale price.
- Additionally, Interest on any deferred consideration must be commercially reasonable.
These changes are designed to prevent excessive valuations (which could unfairly benefit former owners) and maintain fairness for employees.
4. Clarity on Company Contributions to the EOT
It’s common for the company to fund the EOT through annual profit contributions. However, there was concern that these could be classified as taxable distributions under Corporation Tax rules.
From 30 October 2024:
- Contributions used to pay for the share acquisition (and related costs) will not be treated as taxable distributions, eliminating a significant tax uncertainty.
The trustees must essentially claim relief on the trust tax return. Prior to these changes, tax advisors would regularly apply to HMRC for non-statutory clearance to confirm that the payments would not be taxed as distributions. HMRC no longer provides such clearances on the basis that legislation was introduced to exempt such payments from tax, where certain conditions are satisfied.
5. Relaxed Rules on Employee Bonus Eligibility
To qualify for tax-free bonuses, companies must pay them to all eligible employees on equal terms, a rule that previously caused issues for companies with non-executive directors.
Now:
- Directors can be excluded from these payments without violating the “equality” rule.
This gives employers more flexibility in designing their bonus schemes.
Common Challenges When Selling to an EOT
While the tax benefits and employee engagement potential are compelling, EOTs come with real-world complexities that must be considered.
1. High Upfront and Ongoing Costs
Legal fees, tax and valuation advice, and potential restructuring can be expensive. In some cases, these costs can be a barrier for smaller businesses. However, it is worth noting that professional fees would be incurred when selling a company to a 3rd party. This would include legal, tax, valuations and accountancy fees. The fees associated with selling to an EOT are generally not any greater than the fees associated with selling to another purchaser, although the tax benefits are substantial.
2. Valuation Disputes
Valuing private companies is often subjective and may lead to negotiation issues between sellers and trustees. Disputes can delay the process and add costs. However, it is worth emphasizing that negotiating the price with a 3rd party purchaser (i.e. non-EOT) is more a time-consuming process, which generally leads to sales falling through at the 11th hour. Selling to an EOT is therefore generally much smoother, with a higher rate of success.
3. Funding the Acquisition
Unlike third-party sales, there is usually no immediate capital inflow. Most EOTs rely on deferred payment structures, with the company funding repayments out of future profits. Whilst there may be some cash in the business to enable a lump sum payment, the remainder of the consideration (purchase price) is generally payable over several years. It is therefore imperative that the business remains profitable.
Accessing third-party finance may also be difficult, as lenders often demand security, and the company may already have existing loans or charges.
Is an EOT Right for Your Business?
An EOT is not a universal solution, but for the right company, it can be transformational, particularly given that there could be no CGT payable, in comparison to paying tax at 24%! EotOwl are experts on EOTs. Their team can ensure that all statutory conditions are satisfied, and that the transaction is structured in a way which is compliant with tax law and HMRC practice, to mitigate any risks.
EOTs are most suitable for businesses that:
- Have a stable income stream and strong cash flow
- Want to retain their culture and values through succession
- Are looking for an exit strategy that doesn’t involve selling to outside investors
- Value employee engagement and long-term business sustainability
However, EOTs are less viable for companies that are highly leveraged, have volatile revenues, or lack the internal resources to manage the transition process.
Conclusion
The Autumn Budget 2024 has added clarity, integrity, and structure to the EOT landscape. While the changes introduce additional complexity, they also reinforce the spirit of employee ownership, ensuring that control and value genuinely transfer to employees.
With rising Capital Gains Tax rates and fewer opportunities for Business Asset Disposal Relief, EOTs will likely become an increasingly popular route for business owners. However, careful planning and expert advice are essential. This is where EotOwl stand out.
For the right company, at the right time, transitioning to an EOT can be a powerful way to secure the future, for both the business and the people who power it. The tax experts at EotOwl are more than happy to have a totally confidential and transparent conversation if you are interested in exploring this further. Please contact the team on 0203 442 8506 or email info@eotowl.com
