Employee-Ownership Trusts – Who Can Benefit
Under rules introduced in 2014, the owners of a trading company and their employees could benefit from the introduction of a qualifying “Employee Ownership Trust” (EOT). The concept is that control of the company is sold to a Trust, whose beneficiaries are all employees of the company.
The existing owners’ benefit is that they could pay no capital gains tax on the sale of shares to the trust, as opposed to the 10% rate of tax that they would ordinarily expect to pay if they qualify for Entrepreneurs’ Relief on a sale to a third party.
So this does represent a tax saving to them if they believe that their best exit route is a Management Buy Out, or a wider employee share ownership arrangement.
To benefit from the tax exemption the current owners do have to divest control to the EOT immediately, where as in an MBO or EBT arrangement shares could be dripped down.
With the EOT arrangement the current owners may keep shares in the business post disposal of control, but they may not be beneficiaries of the Trust.
The beneficiaries of an EOT (the employees), will not have any income tax liabilities on the trust receiving the shares, because the shares are held in trust rather than the direct ownership of the employees.
This is a significant benefit of the EOT arrangement, because mitigating an income tax charge on employees receiving employment related shares is often difficult. An EMI share option scheme could typically shelter employees from such liabilities but EMI Options do not apply to all trades (eg typically not professional firms) and to be effective the options need to be granted when the shares are of low value.
Also of benefit to the employees is that discretionary bonuses that they receive in the future from the EOT controlled company could be tax free up to £3,600 per year (although NI is still payable on such bonuses). The company still receives a corporation tax deduction for the tax free bonuses.
Structure of Buy-out
Some care needs to be taken as to how the EOT funds the purchase of the controlling interest. Loans to participators from EBTs can attract adverse tax implications and a deferred consideration mechanism may be appropriate.
If the owners of the trading business genuinely believe that the best people to take over control of their company are management or its employees, then the EOT arrangement does represent an attractive option.
The conditions of reliefs are quite onerous though, and a good deal of work needs to be done to establish whether an effective structure can be developed as to how employees benefit and exert influence.