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Tax Bite – Latest position on EOT reforms – January 2025 update

In the Budget on 30 October last year, various changes were announced to the rules on sales to employee ownership trusts (EOTs). Most of the changes were aimed at tightening up the conditions for CGT relief, seemingly to address perceived abuse, examples being:-

• extending the period for disqualifying events (under which the CGT relief is withdrawn) from one to four tax years after the tax year of sale;

• requiring EOT trustees to be UK resident and independent of the main selling shareholders; and

• requiring the EOT trustees to ensure that the purchase price for the business does not exceed market value and that any rate of interest on deferred consideration doesn’t exceed a reasonable commercial rate.

In addition there was what at first appeared to be a welcome clarification that contributions from the company to the EOT could be relieved from the charge to income tax as dividends / distributions in the hands of the EOT trustees. Previously, standard practice was to seek a non-statutory clearance from HMRC, on a case by case basis, that such contributions would not be treated as distributions. HMRC would routinely grant such clearances.

The main problems with the draft legislation (in Finance Bill 2025) implementing this change were that (a) it appeared to intimate that contributions to the EOT would be distributions, i.e. the draft legislation provided for a claim for relief from the charge to dividend tax on contributions, and (b) the contributions that were capable of being so relieved were limited to amounts required to pay the purchase price for the shares in the company, any reasonable rate of interest on the deferred consideration, and stamp duty on the purchase. That left uncertainty over the tax treatment of any other contributions to the EOT by the company.

After lobbying, the government has now proposed amendments to the Finance Bill such that the “relievable” contributions would be extended to cover repayment of sums borrowed to fund the share purchase, amounts spent on valuation of the company for the purposes of the purchase, and other reasonable expenses directly connected with the acquisition (this should include for example legal costs), but specifically not expenses incurred in connection with the ownership of the shares after the acquisition.

So, whilst this is an improvement, it still leaves the treatment of contributions to the EOT to meet post-transaction expenses unclear. It is possible that HMRC will still grant non-statutory clearances that such amounts are not distributions on the facts of a case, although that would be very unsatisfactory i.e. leaving the tax treatment of what should be small post-transaction expenses hanging on a clearance application in every case.

Overall, the key message on EOTs from a tax perspective is that the CGT relief continues to exist and can be hugely beneficial, particularly with CGT having increased to 24% and BADR rates increasing shortly. Sales to EOTs have become increasingly popular and are likely to remain so despite the tightening of the CGT relief conditions. One important aspect that was not changed in the Budget is that the relief remains unlimited, so sellers can achieve a tax free sale whatever the deal size as long as no more than market value is paid. However (and all the more so in light of the recent changes, which are to apply to sales on or after 30 October 2024) an EOT sale should only be pursued where it is right for the company commercially and culturally, and where the selling shareholders fully understand what it means to move into EOT ownership with all the requirements and clawback risks associated with the tax relief.

If you would like to discuss any of this or have clients contemplating a possible sale to an EOT, please feel free to get in touch.