Employee Ownership Trusts

Selling a company to its employees has become more popular due to the benefits of shared ownership and government incentives. A key factor is the Employee Ownership Trust (EOT), which allows owners to sell their stake while giving employees a vested interest in the business. With provisions from the Finance Act 2014 and updates in the Finance Bill 2024-25, EOTs offer significant tax advantages, including a capital gains tax (CGT)-free sale for vendors and income tax-free bonuses of up to £3,600 annually for employees.

While the benefits of an Employee Ownership Trust (EOT) can be enticing, it’s important to recognise that the EOT is primarily a business structure, not just a tool for saving on taxes. Poor planning or a poorly structured EOT transaction could harm a company’s financial health and pose challenges in repaying any deferred payments to former shareholders.

Why Employee Ownership Is Gaining Traction

Employee ownership isn’t a new idea, but it has become more prominent in recent years—particularly in the UK, where the Employee Ownership Association reports over 1,650 employee-owned businesses. Several factors contribute to this popularity:

1. Enhanced Productivity: Research shows that employee-owned companies are often more productive and innovative. When employees have a direct stake in the company’s success, they feel more empowered to make improvements and solve problems.
2. Greater Resilience: With employees collectively invested in the enterprise’s success, companies tend to demonstrate greater resilience in economic turbulence. Employees are motivated to safeguard the business during downturns, uniting to preserve value and secure jobs.
3. Talent Retention and Engagement: Shared ownership frequently translates into better employee engagement, job satisfaction, and lower turnover. People are more likely to stay in a workplace that allows them to benefit directly from its financial growth.
4. Tax Advantages: EOTs allow shareholders to sell their shares without paying Capital Gains Tax. Employees can also receive up to £3,600 in tax-free bonuses each year. These benefits connect the goal of selling the business with the well-being of employees, making EOTs a good option for everyone involved.
5. Succession Simplification: For business owners wishing to retire or reduce their active involvement, an EOT can streamline succession. You can transition from day-to-day operations, knowing your legacy is in the hands of those who truly know and value the business.

Understanding the Employee Ownership Trust Structure

An EOT functions as a discretionary trust that acquires a controlling stake in the company from the existing owners. The key principle is that employees benefit from that ownership rather than having the equity consolidated in just a few hands.

Trustee Independence Requirement

The Finance Bill 2024–25 introduces new rules that prevent the vendors (the selling shareholders) from constituting 50% or more of the trustee board or controlling the trustee company. This rule is designed to ensure that employees genuinely benefit from the EOT and that the former owners do not retain de facto control. For disposals on or after 30 October 2024, EOTs must meet this so-called “trustee independence requirement.”

The Role of TrustCo

A common tactic is to create a new company—often referred to as TrustCo—to serve as the sole corporate trustee. TrustCo’s board typically includes:

• A representative of the vendors (particularly if they have outstanding deferred consideration).
• One or more elected representatives of the employees.
• An independent trustee, ensuring impartial oversight.

In this setup, TrustCo itself doesn’t own the shares in any personal capacity; it simply holds them on behalf of the EOT. TrustCo may be structured as a company limited by guarantee, so it won’t even display share capital on its balance sheet.

Beneficiaries of the Trust

The EOT must be set up so that the primary beneficiaries are the employees collectively. Any exclusions must be based on specific justifications—such as instances where an employee is deemed a “participator” in the company.

Sale Value and Independent Valuation

Because trustees bear a fiduciary responsibility to the employees, they must not overpay when purchasing shares from the vendors. Legislation effective for disposals on or after 30 October 2024 codifies this duty, requiring an independent valuation to confirm a fair sale price. If vendors opt to sell for below the established market value, that’s allowed from a tax perspective, as paying under market value does not create adverse tax consequences for the vendors.

Funding the EOT Transaction

Many EOT deals are financed through a combination of existing company cash reserves and deferred consideration, paid out of the company’s future profits. In these scenarios:

1. The company pays funds to the EOT (treated as “contributions” if certain conditions are met).
2. The EOT then pays the vendor shareholders the agreed portion of the sale price.

Distributions Relief

Previously, it was common to request a non-statutory clearance from HMRC to confirm that the funds passed to the EOT would not be taxable distributions. However, for distributions made on or after 30 October 2024, there is now a statutory relief explicitly covering payments used to fund the trustee’s “acquisition costs.” After consultation with professional bodies such as ICAEW, the scope of this relief was broadened to cover more typical scenarios. A claim must be submitted to HMRC to avail of this relief.

Bank Funding

If vendors need a larger initial payment, they can look into third-party financing options. The trust could also get a loan, but that can complicate things since it usually doesn’t have much collateral apart from the company’s shares.

Accounting Implications

When setting up an EOT, it’s helpful to grasp how the arrangement will be represented financially:

1. TrustCo Accounts: Since TrustCo is simply a corporate trustee and not the beneficial owner of the shares, it typically does not register them as an asset on its own balance sheet. Often structured as a company limited by guarantee, TrustCo may have no share capital.
2. Trust Accounts: If the discretionary trust (the EOT) prepared a balance sheet, it would show:
   • An investment in the target company (the newly acquired shares).
   • Any deferred consideration to the vendors as a liability.
3. The trust must comply with standard trust obligations, which include registering with HMRC and possibly filing tax returns, particularly given the newly introduced distribution relief rules.
4. Taxable Income for the Trust: Up to 29 October 2024, contributions to the EOT were generally not taxed as distributions based on individual HMRC clearance.
   • From 30 October 2024 onward, EOTs may have taxable income unless a relief claim is successfully filed. While the relief covers distributions used to pay down acquisition costs, there is some ambiguity regarding how the trust can handle day-to-day expenses—such as professional fees to independent trustees.
5. Company Accounts: The trading company (or group) should not have to consolidate TrustCo or the discretionary trust in its financial statements. Deferred consideration owed to the vendors is recorded as a liability of the trust, not of the operating company. Consequently, you won’t see large liabilities for share purchases on the company’s balance sheet.

Ensuring Compliance with Evolving Legislation

The Finance Bill 2024–25 introduces a new trustee independence requirement and expands distributions relief. For EOTs established before 30 October 2024, HMRC will honour prior clearances, but ongoing operating cost handling is unclear. New EOTs must align their agreements with the updated legislation to avoid tax liabilities or compliance issues.

Is an Employee Ownership Trust Right for You?

Deciding whether an EOT fits your business model hinges on multiple considerations:

• Company Viability: Does the business consistently generate healthy profits to support any deferred consideration?
• Management Continuity: Do you have a capable management team that can drive the business forward post-sale?
• Employee Buy-In: Is there a genuine desire among employees to take on shared ownership and a bigger role in governance?
• Future Growth: Does the company have growth potential that can flourish under collective ownership?

While the CGT-free sale and tax-free bonuses are powerful draws, an ill-suited or poorly planned EOT can strain the business financially. It’s crucial to seek professional advice to conduct a thorough feasibility analysis.

Your Next Steps and How We Can Help

Employee Ownership Trusts (EOTs) are an attractive alternative to selling a business. They offer important tax benefits, make succession easier, and allow you to reward the people who help your business succeed. However, you need to carefully plan to meet new legal requirements, ensure accurate business valuations, secure proper funding, and comply with HMRC rules.

At Tax Accountant, we specialise in:

• Conducting robust feasibility studies for prospective EOTs.
• Guiding you through the valuation process to ensure fair pricing.
• Structuring the trust for maximum tax efficiency and compliance.
• Advising on financing options, including the viability of deferred consideration and external lending.
• Handling the necessary HMRC filings, distribution relief claims, and trust-related administration.

Selling your company to its employees is more than a financial transaction; it’s a transformative approach that can enhance workplace culture and resilience. Employee Ownership Trusts (EOTs) offer tax benefits and operational advantages, though they come with responsibilities and regulatory challenges. With expert guidance, an EOT can be a rewarding succession plan for both owners and employees.

Interested in how an EOT could work for your business? Contact our team to navigate the complexities, optimise tax efficiency, and ensure a smooth EOT transition.