Shareholders of trading companies, who wish to share ownership with their employees, can sell some or all of their shares to employee ownership trusts (EOTs) without incurring capital gains tax. Matthew Grief, Tax Specialist at Moore looks at the benefits for business owners looking to move on or retire.
The impacts of Brexit and COVID on the UK economy have led to uncertainty about the future – and business owners looking to exit can find it difficult to find a traditional buyer. However, the good news is that there are alternatives.
EOT (Employee Ownership trusts) are a type of employee benefit trust which let shareholders transfer controlling interests in their companies to their employees. Inspired by the John Lewis model, EOT’s were introduced by the government in 2014, and bring attractive tax benefits to both the shareholder and the employee.
Provided conditions are met, a shareholder can sell their shares to an EOT without incurring any capital gains tax (CGT). This will particularly interest shareholders who do not benefit from business asset disposal relief or investors’ relief, (and who would otherwise have to pay CGT on transfers of their shares at 20%). Additionally, by transferring shares into an EOT, there is usually 100% relief from inheritance tax which would otherwise apply.
For the employees, there’s the opportunity of a tax-free cash bonus of up to £3,600 per employee per year.
Even when other exit options such as external sales or management buy-outs are available, many business owners prefer to leave the business in the hands of their employees. When employees have a stake in the business, you will often see greater employee engagement and improved recruitment and retention rates.
An EOT can be a good way of securing a company’s future whilst maintaining its independence. It can also prove to be a boost to the company’s corporate social responsibility profile – EOTs have strong connotations for the media and public.
Without going into all the technicalities, the following conditions must be met, in order to qualify for the CGT relief:
- The company must be a trading company or the holding company of a trading group.
- Trustees must ensure that all property and assets settled into the EOT benefit all eligible employees on the same terms.
- The transfer must be of at least a 50% controlling interest, this must be retained on an ongoing basis.
- The number of continuing shareholders who are directors or employees must not exceed 40% of the company’s total employees.
If there are any ‘disqualifying events’ following the transfer, tax relief may be lost for the transferring shareholder. Disqualifying events include loss of the company’s trading status, ceasing to meet the all employee benefit requirement, ceasing to meet the controlling interest condition and/or failure to meet the ‘limited participation’ requirement.
As well as the ongoing requirements for tax relief, the trustees must also ensure all trust law and governance requirements are met. N.B. The above provides a brief summary of EOTs and should not be relied upon without taking further advice.
Since their creation, EOTs have had a ‘slow start’, but they are gaining in popularity as businesses become more aware of them. Any shareholders of a company considering an exit or succession should give some thought to using an EOT as one of the options available.