Publish Date
Jan 11, 2022
A&M Tax Advisor Update
An Employee Ownership Trust (EOT) provides a structure for the sale of a trading business to a special trust for the benefit of the businesses’ employees and enables owners to sell their shares free from capital gains tax (CGT), where certain statutory conditions are met.
Since the EOT model was launched by HMRC under the Finance Act 2014 and up until June 2021, there were 576 sales of businesses to an EOT, and Q1 of 2021 saw a record number of 72 transactions [1]. This data illustrates that increasing numbers of owners are selling their businesses to an EOT and an EOT exit has become a credible exit strategy for business owners.
In this briefing, we look at some of the reasons behind the growing popularity of sales into this structure and why now might be a good time to sell to an EOT.
The pandemic and the current economic environment have had different impacts on business owners.
For some owners, the pandemic has focused thinking on lifestyle priorities and succession planning. One of the advantages of an exit into an EOT is that the owners are not required to divest the entire share capital in the business to an EOT. There is a minimum requirement of a 51% sale of the issued ordinary share capital to the EOT which provides flexibility regarding the level of exit for shareholders under the statutory construct. Owners can therefore retain up to 49% of the ordinary share capital in the company to benefit from further upside whilst taking “cash off the table” to pursue other interests (albeit the CGT relief discussed below is a one-off relief, so it would not be possible to take advantage of the relief in relation to a subsequent disposal of the remaining 49% in a future tax year).
The sale to an EOT can also enable a gradual succession to continuing management. If the successor management team is not quite ready to step into the shoes of the founders, a sale into an EOT enables the founders to remain involved in the business post-sale permitting a transfer of skills and experience to continuing management.
Extraordinary COVID financial relief measures have contributed to tax rate uncertainty as the Chancellor seeks to balance the books.
Again no change to CGT rates was announced at the Autumn Budget and the main rate remains at 20%, with an individual shareholder potentially accessing business asset disposal relief at a 10% rate capped at £1million of gains (subject to various conditions being met). However, the tax rate on dividends is increasing by 1.25% in April 2022 to help fund the health and social care levy announced in September 2021, which will raise the top rate to 39.35% where returns to shareholders are taxed as dividend income.
In contrast, a qualifying sale to an EOT enables an owner to realise capital gains at 0% on an uncapped basis. This makes an EOT a highly tax-efficient route for sellers disposing of shares they hold in a company where the statutory conditions are met and the structure meets the sellers’ objectives.
There is research to show employee-owned businesses are more resilient during a downturn due to levels of employee commitment and engagement during difficult economic conditions. The Employee Ownership Association Impact Report referred to:
“One of the consistent findings emerging from research into the advantages of employee ownership is that of greater resilience than non-employee owned businesses during the economic downturn.” [2]
The 2017 Ownership Effect Enquiry: What Does the Evidence Tell Us?” backed this up representing that:
“UK based evidence suggests that employee owned firms are more resilient than non-employee firms.” [3]
Economic resilience and longevity are usually very important to founders who wish to ensure the continuity of their business and preserve the legacy they have built.
In addition to the tax benefits for the selling shareholders, employee-owned businesses can reward their employees by the payment of cash bonuses of up to £3,600 per year free of income tax.
In addition, share schemes such as Enterprise Management Incentive Schemes, can still be operated outside the EOT to award equity incentives to key management.
Distributions can be made from the EOT to employees without employees having contributed their own money to become “indirect owners” of the business.
An EOT effectively creates an exit event for the current shareholders without the need for an external third-party. This means once the owners decide to proceed, the transaction can progress with a reduced risk of falling over and with a significantly reduced requirement for due diligence enabling employees and managers to continue with the business as usual.
In conclusion, there are a number of reasons why now might be a good time to consider a sale to an EOT.
The team at A&M Tax would be happy to talk through the considerations of implementing an EOT with you and how we can help you structure a sale to an EOT. Please contact your A&M point of contact or Samantha Lenox or Louise Jenkins from our Reward & Employment Tax Solutions team.
