What are Employee Ownership Trusts (EOT)?

Most people know that John Lewis led the way on employee ownership in the UK, and in 2014, specific tax reliefs were introduced to incentivise “indirect” employee ownership of companies. 

Indirect employee ownership is ownership of the company via a trust benefiting employees as opposed to the company’s shares being owned directly by employees.

This occurred through a new type of tax-advantaged trust known as an EOT (Employee Ownership Trust). 

Initially, there was limited take-up of the EOT tax reliefs, but business owners have started to realise the advantages of EOTs when it comes to selling their businesses as the tax reliefs are available not just for gifts of companies to an EOT, but for sales of companies to EOTs at full value.

So not only does an EOT allow a business owner to pass on their business to their employees as a legacy of future employment, but it also allows the business owner to sell their company to a newly set-up EOT for full value completely free of Capital Gains Tax (CGT) and Inheritance Tax.

Sale of shares to an EOT – what are the tax reliefs?

Capital gains tax exemption

From 6 April 2014 an individual (or trust but not a company) who gives or sells their shares to an EOT, leading to the EOT having a controlling interest in that company by the end of the tax year which it did not have at the start of the tax year, will have a complete exemption from CGT on the sale/gift of their shares to the EOT.

The shares benefiting from this CGT exemption have to be sold to the EOT in the tax year in which the EOT first acquires a controlling interest. A controlling interest for these purposes means the EOT holds more than 50% of the ordinary share capital and voting rights and must be entitled to more than 50% of the company’s profits and assets if it is wound up.

Other conditions that need to be satisfied to qualify are: –

• The trading requirement: The shares must be in a trading company or holding company of a trading group.
• The all-employee benefit requirement: The EOT must be established for the benefit of all employees of the company (excluding, broadly, individuals who hold or have previously held 5% of the shares).
• The participating and equality requirements: All eligible employees must be able to benefit from the EOT (the “participation requirement”) and they should do so on the same terms if there is ever a distribution from the EOT (the “equality requirement”). In this latter requirement, the company can, to an extent, differentiate on the grounds of salary, length of service or hours worked.
• The limited participating requirement: The number of continuing shareholders who are directors and employees must not exceed 40% of the total number of employees of the company or group.

Employee annual bonus exemption

A company owned by an EOT can pay bonuses of up to £3,600 per employee per tax year free of income tax (but not NIC) if these bonuses are paid to all qualifying employees on a “same terms” basis.

Who might be interested in an EOT?

Any owner-managed company whose owners are thinking of selling their company or who want to realise some of their capital value from a sale of a controlling interest to an EOT. 

Because of the nature of their businesses, we think this might be of most interest to companies where the pyramid structure between employees, management and owners is fairly flat, such as those in advertising, design, publishing, fashion or music, architects, quantity surveyors, management consultancies or healthcare companies. 

However,  no company should rule it out, as we know of printing companies, manufacturing companies and retail companies that have successfully transitioned to employee ownership using an EOT.