Employee Ownership Trusts – how can they work for your business?
Employee Ownership Trusts (EOTs) enable business owners to transfer a controlling interest in their business into employee ownership without paying capital gains tax (CGT).
Pictured: Sheryl Davis, Partner and Richard Meller, Director
Growing a business comes with an increasing need for cash. While cash for investment is well understood, the requirement to increase working capital is often overlooked and is a key reason for business failure.
What is an Employee Ownership Trust (EOT)?
An EOT is a specific type of Employee Benefit Trust(EBT) introduced by the government in 2014 to reward employees and encourage employee engagement. An EOT provides an indirect form of employee ownership whereby the trust holds a controlling stake in a company on behalf of all the company’s employees.
Where a shareholder sells a controlling stake in their business to an EOT and qualifying conditions are met there can be significant tax advantages. This makes EOTs useful in succession planning as an alternative to an external sale, a private equity backed buy-out or a management buy-out (MBO).
How does selling to an EOT work?
Put simply:
- A qualifying EOT is set up.
- The business owners sell more than 50% of the current share capital to the EOT for market value (using an independent valuation). The purchase price is left outstanding as a debt owed by the EOT to the selling shareholders (or the EOT can make an initial payment to the shareholders using third party debt finance, leaving only part of the sale price outstanding).
- The company uses future profits to make contributions to the EOT and the EOT uses these payments to repay the outstanding purchase price owed to the selling shareholders.
Qualifying conditions
Determining the price which the EOT must pay for the shares is of critical importance – setting this too high risks the trustees being found to be in breach of their duty of care towards the employees as beneficiaries of the trust.
These are the key conditions which must be met for the selling shareholders to benefit from the
CGT exemption:
- The company must be a trading company or the principal company of a trading group.
- All employees must be entitled to be beneficiaries of the EOT, subject to a qualifying period of up to one year and any benefit to employees must be on the same terms for all eligible employees. So the trust cannot prioritise benefits to the advantage of particular employees, but it can allocate benefits of differing amounts according to factors such as salary and length of service.
- The EOT must not hold a controlling interest in the company (ie more than 50% of ordinary share capital and voting rights, profits available for distribution and 50% of the assets on winding up) before the tax year of the transfer and must hold a controlling interest at the end of the tax year in which the transfer takes place.
- The number of continuing shareholders (and any other 5% participators) who are directors, employees or persons connected with them must not exceed 40% of the total number of employees of the company or group.
To read our full article and to find out more, click here.
Alternatively, if you have any questions on this topic, please get in touch with:
Sheryl Davis
Partner
High Wycombe
E: [email protected] T: +44 (0)1494 416 080
Richard Meller
Director
Bournemouth
E: [email protected] T: +44 (0)330 094 2066
