The future of Employee Ownership Trusts?

In July, the Government launched a consultation on the structure and taxation of Employee Ownership Trusts (EOTs). It will close on 25 September. But what is the Government proposing and what might it mean for the future of EOTs?

EOTs were first introduced in 2014 designed to promote employee ownership of a business. Business owners can, with attractive tax advantages, sell their business or shares in the business to a trust owned by its employees.

It is important to note that employees do not directly own shares in the business; a controlling interest in the company is held by an all-employee trust and held in benefit for the company’s employees.

Whilst still not widely adopted, they are expanding and growing in popularity. The Employee Ownership Association, a trade body, reports that as of the end of 2022 there were 1,418 employee-owned businesses with 90% of those held via the EOT structure. In 2022, 332 new EOTs were registered – almost one for every working day of the year.

For some companies, there are good reasons to consider an EOT as a way for shareholders to exit a business and to incentivise employees.

First and foremost, for employees who have often been instrumental in building that business, it provides the opportunity to ‘own’ that business and to shape its future growth and direction. Employees can also receive a £3,600 tax-free cash bonus every year.

There is a tax-sweetener too. Business owners can sell free of capital gains tax. Not all shareholders need to sell, and those that do can remain employed by the business and receive remuneration. It is also seen as an easier and more friendly way to sell the business.

So why when the scheme appears to be working as it was designed is the Government consulting to make changes?

Trustee appointments

The current regulations do not place any restrictions on who can be appointed as a trustee. The current business owners often wish to retain some continued control over the business and appoint themselves.

Whilst there is of course merit in the business being able to continue to tap into the expertise of individuals who have a long association with it, questions have been asked whether the spirit of the rules are being upheld. Should a business owner be able to sell the business to an EOT with all the tax benefits yet retain control over that business?

The consultation proposes to restrict the business owners who are selling from a controlling interest in the EOT requiring at least half of trustees to be individuals who are not former owners or connected to them. Where this is later found to be the case, the tax benefits of the sale to an EOT would be extinguished with an automatic capital gains tax liability arising.

Non-resident trustees

Currently, it is possible for a business owner to appoint trustees who are non-resident in the UK. There can be good reasons to do so – for example when a business has an international footprint.

However, there is a concern that in some cases non-UK resident EOTs are only used for tax planning purposes as it would not be liable for capital gains tax on any subsequent disposal. 

The consultation proposes that trustees of an EOT be UK resident as a single body of persons. Although non-UK residents can be appointed, the EOT as a whole will be taxable in the UK..

Tax-free bonuses for employees

The current rules surrounding the £3,600 annual bonus were deliberately designed to be restrictive so they cannot be weighted in favour of directors or the highest paid individuals. This has in some circumstances made it difficult to award that annual business, particularly when a business has overseas subsidiaries or where employee non-executive directors exist.

The consultation proposes to make it easier to award bonuses to employees without necessarily having to include directors in that scheme. It will, the Government hopes, make the tax-free bonus a key feature and incentive for sale to an EOT.

Funding issues

It is not uncommon for new EOTs to have limited funds to pay upfront for the purchase of shares from the business owner. Payment is often made over an extended period of time through the profits the business makes. Such arrangements can trigger tax liabilities, meaning businesses look first to seek HMRC approval. Here, the consultation proposes to make the legislation clearer to reduce uncertainties and the requirement for such clearances.

The James Cowper Kreston view

The proposals in the consultation should help to simplify EOT arrangements, continue to place EOTs as an attractive exit route for business owners and as a way to reward staff in any growth journey.

There will still, however, be much complexity and they do not work in all situations with both business owners and employees needing to understand the short and long-term implications. More traditional management buyouts, for example, may be a more attractive option for many companies.

Whether you are an existing business hoping to reduce your shareholdings or an employee wanting to get more involved in your employer we can help you assess your options.

The consultation, which closes for comments on 25 September, can be found here.

 For more information, please contact a member of our Business Tax team.