Employee Ownership Trusts – Capital Gains & Inheritance Tax

Author

Rachel Wagstaff

Rachel joined ETC Tax in January 2018 having worked in tax for the past 6 years.

Employee Ownership Trusts (EOTs); Definitions & Examples…

What is an EOT? A Definition by Example

New legislation surrounding Employee Ownership Trusts were brought in under Finance Act 2014 with the aim to encourage more companies to adopt an indirect employee ownership model.

Indirect employee ownership models aim to incentivize employees by giving them a share of the company via a trust. The trust collectively holds the employee shares for the long-term benefit of the employees.

Research shows that employee owned companies can have a number of benefits including growth and sustainability as well as greater staff motivation and retention. The fact that the employees can participate in the success of the company, and have a greater voice and responsibility brings ongoing benefits to the company.

FA 2014 introduced certain tax advantages to EOTs to encourage this form of business model.  The tax reliefs include capital gains tax and inheritance tax reliefs on the disposal of shares to an EOT and an income tax relief on certain bonuses to employees of a company owned by an EOT.

Relief 1 – Capital Gains Tax Relief on the transfer of shares into an EOT

It is possible for the owners of a company to dispose of their shares to an EOT without crystallising a CGT charge where a controlling interest (i.e. the majority of the shares) is transferred into the EOT. The shares are effectively transferred so that the disposal is deemed to be at no gain/no loss which is why there is no capital gains tax arising on the individual.

There are a number of requirements that the company will need to meet in order for the relief to be available to the shareholders. The requirements are complex and stringent, the below list is not exhaustive but gives a broad outline of the requirements:

Trading requirement – the company must be trading at the time of disposal and not include any substantial elements of investment or non trading activities. It must continue to fall under this trading requirement for a period of time after the transfer.

All-employee benefit and equality requirement – the EOT must be open to all eligible employees under the same terms (subject to certain exclusions). Variances can be made in reference to the employees’ length of service, remuneration and hours worked.

Controlling Interest requirement – More than 50% of the ordinary share capital, voting rights and distribution or assets upon winding up must be transferred into the EOT. This means that the EOT is now the majority shareholder and controls the company.

Limited participation requirement – There are rules which restrict the relief when an individual sells their shares to an EOT but they (or their family) continue to hold shares within the company after the conversion to the EOT.

If the above conditions are met, then it is possible for the transaction to occur CGT free. However, the conditions must also be met for a period of time following the disposal in order to prevent a claw back of the relief.

It is often the case that the EOT does not immediately have the funds to pay the exiting shareholder for the shares. If they are willing to wait for the proceeds it can be agreed that the market value consideration for the shares will be paid over a number of years.

This will mean that the profits of the company over the period can be contributed to the EOT to allow the EOT to make the deferred consideration payments.

Relief 2 –  Inheritance Tax (IHT) & Employee Ownership Trusts

The legislation also states that a disposal of qualifying shares into an EOT will not be a chargeable transfer for IHT purposes provided that all the conditions are met.

As the trust is for the benefit of employees, the trust itself is also exempt from the ten yearly and exit charges on distribution.

Relief 3 – Income tax relief on bonuses to employees

Employees of a company owned by an EOT, can receive a bonus of up to £3,600 per annum income tax free.

The relief is from income tax only and does not apply to employer or employee National Insurance contributions.

Interaction with Tax Advantaged Share Schemes

It is still possible due to amendments made to cater for this, for an EOT owned company to participate in other tax advantaged share schemes such as EMI, CSOP, SAYE and SIPs if the company would qualify for these schemes. Care needs to be taken as the EOT must maintain more than a 50% holding in order to avoid any claw back of relief. If the holding in the EOT is close to 50% then this will need to be carefully monitored.

The all-employee benefit requirement must also be adhered to so care should be taken in relation to schemes which are not open to all employees on similar terms such as EMI, however with appropriate advice such a scheme can be implemented in a compliant manner.

Next Steps & Examples

The article provides a brief overview of what an employee ownership trust is and the reasons it may appeal to certain companies. They are often used as succession planning when the current owners of the business are looking to retire and have a strong workforce in place to take over the business.

This is a complex area of taxation and the above is intended only to provide a general overview. If you are contemplating an EOT structure, professional advice should be sought. Our advisors would be happy to assist with any tax queries and as well as the implementation of an EOT.

Enterprise Tax Consultants can advise on all aspects of Employee Ownership Trusts

Like this article? Read more about Employee Ownership Basics & Employee Share Schemes…

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