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Tax Bite – Employee ownership trusts (EOTs) survive Budget unchanged

EOTs were introduced to promote employee ownership of companies, and the tax benefits (the principal one of which being a complete CGT exemption for the selling shareholders on the sale of a controlling stake in the company to an EOT, subject to various conditions) were intended to encourage such transactions and ownership structures.

A consultation into EOTs was announced as part of Budget 2023 and we issued a Tax Bite on this in May 2023.

The consultation started on 18 July 2023 and closed on 25 September 2023 and a summary of what was proposed in that consultation, along with some of our thoughts on the proposals, is set out below. Since the consultation closed, there have been two fiscal events (Autumn Statement 2023 and Budget 2024) but no new announcements have been made regarding EOTs, in spite of the consultation closing almost 6 months ago.

So the news for now is that the EOT regime and the tax advantages it can offer continue unchanged after Budget 2024. However, it is entirely possible (perhaps even likely) that changes may be made in the short term. We will of course provide a further update on these proposals as and when there are any further announcements.

The EOT consultation

The government said in the consultation that the tax advantages offered by the EOT regime had been successful in making EOTs the predominant model for employee ownership in the UK, with uptake of the model continuing to increase. However, it is clear that the government is keen to ensure that the tax reliefs offered are not abused to give tax advantages to company owners without any genuine increase in employee engagement.

The proposals that were considered as part of the consultation were:

• Imposing a new requirement on the make-up of trustees of an EOT (presently there are no such restrictions), so the former owners of the company (and any persons connected to them) do not make up a majority position of the trustee board. This is driving towards the goal that EOTs should deliver meaningful change for the employees, but also in how the business is operated in future (i.e. for the benefit of the employee group as a whole, rather than continuing without any change in control at all). The consultation recognised that the ongoing involvement of former owners may be valuable (e.g. for their expertise) to the business, so there is no proposal to prevent them being trustees altogether. Commercially any former owner with deferred consideration outstanding will be keen to have some influence in how the business moves forwards.

• Preventing trustees of EOTs from being non-resident for UK tax purposes. Presently it is possible for non-UK resident trustees to be appointed to an EOT, which in turn will mean that the EOT remains outside of the UK tax net in future, which could undermine the effect of the existing clawback rules that apply when an EOT ceases to have a controlling stake in the company concerned. This may not be what was intended by the original legislation and we are aware that offshore trustees are quite common in larger transactions particularly where an onward sale is likely (see below).

• Clarifying the existing law that contributions from the company to an EOT shareholder will not be taxable distributions (dividends) or treated as loans (which could create a loan to participator problem for the company), in the hands of the EOT trustees. The law is unclear on these points although presently HMRC take a generous view and is customarily giving clearance that this is the case where it is asked to do so. This would be a welcome change to clarify how the existing rules apply in this situation.

• Relaxing certain restrictions around the payment of the tax-free employment bonus of up to £3,600 per year, as there are cases where specific facts are preventing these bonuses from being paid in practice.

Perhaps importantly, it should be noted that the consultation did not consider:

• increasing the percentage of the company that must be sold to the EOT to qualify for CGT relief – a simple 51% controlling majority stake is all that is required and it looks like that is set to continue;

• scaling back the complete CGT exemption, for example by introducing a cap on tax-exempt gains, to try and discourage decisions being influenced too heavily by complete CGT exemption rather than promoting employee ownership; or

• extending the period in which the sellers’ gain could become taxable if the EOT loses control. Currently, as long as the EOT trustees keep control until the end of the tax year after the transaction, the sellers escape any tax. This (and the absence of any kind of motive test on the transfer to the EOT) mean it is becoming common for sellers to park the shares in the EOT and then there to be an onward sale fairly quickly whereby any deferred consideration is paid down.

For now, the rules remain as originally introduced and although it doesn’t look like the major tax benefits of an EOT structure will be changed there is no way of knowing what view will be taken by a new government after an election. Therefore, clients planning to sell to an EOT may be best advised to press ahead.