An Employee Ownership Trust (EOT) is a type of Trust where trustees own and control the company for the benefit of all employees. Introduced in 2014, EOTs enjoy significant tax breaks and have become an increasingly popular ownership model. Hazlewoods have been active in the EOT field from its introduction.
In the summer of 2023 HMRC conducted a consultation which sought views on proposals to ensure these tax benefits are used as intended and we put forward our thoughts. After a lengthy pause the outcome of the exercise was released as part of Rachel Reeves’ first Budget.
The consultation proposed reforms to prevent former owners from controlling the EOT trustee board post-sale. Most respondents supported this, seeing it as sensible, though they emphasised the value of former owners on the board in non-controlling roles for their experience. The Government confirmed it would introduce restrictions to ensure former owners and their connections cannot control the company post-sale through the EOT.
Tom Woodcock’s View:
“This is a sensible step and reflects the advice we have always given. It is fundamental that the transition to Employee Ownership is a genuine handing over of the reigns.”
Most respondents agreed that it is best practice for EOT trustee boards to include an employee representative and an independent trustee, but opinions were mixed on mandating this as a legal requirement. Overall, respondents emphasised the importance of flexibility in trustee board composition (subject to the control point above), and the Government does not intend to mandate specific trustee group requirements.
Tom Woodcock’s View:
“We advise that trustees include a vendor, an employee and an independent but that isn’t always appropriate or viable. Mandating the makeup of the trustee board might be unnecessarily restrictive.”
The consultation proposed requiring EOT trustees to be UK residents to prevent tax avoidance through offshore EOTs. Most respondents supported this, believing it would prevent offshore trusts from avoiding Capital Gains Tax. The Government will implement this requirement from 30 October 2024 but EOTs established before this date are exempt.
Tom Woodcock’s View:
“Overdue in my view. Offshore trustees tend to make HMRC inquisitive, and it is seldom that you find a compelling commercial reason for their use in an EOT transaction.”
EOTs are typically funded by distributions of profits from the company to the trustees. Due to uncertainty in the tax treatment of these distributions, it has become routine to seek clearances from HMRC in advance. The consultation proposed changes reducing the need for these clearances which are customarily given, and respondents were overwhelmingly in favour of confirming the treatment in legislation. The Government will introduce a new relief which will apply to contributions made to the trustees to fund costs on or after 30 October 2024.
Tom Woodcock’s View:
“This is helpful in that the proposed relief reflects what has historically been agreed by HMRC and lengthy clearance applications will no longer be required.”
As part of the tax incentives designed to encourage the formation of EOTs, an employee-owned company can pay up to £3,600 annually as a tax-free bonus to its employees. There are strict rules which govern the payment of the bonus and the consultation proposed targeted changes to address various concerns. The Government will ease the bonus rules so that bonuses can be awarded to employees without directors having to be included, but did not increase the £3,600 limit which has been in place for 10 years.
Tom Woodcock’s View:
“This is welcome in so far as it goes. The failure to increase the income tax free bonus limit is disappointing given its diminishing value to employees.”
As part of the consultation HMRC also asked for suggestions on how the EOT regime could be improved. The suggestions put forward were many and varied and of these the Government have chosen to respond to three in particular:
The current ‘vendor clawback period’ of 12 months within which tax relief can be withdrawn from the former owner if the EOT conditions are breached, will be extended to the end of the fourth year following the year of disposal and after which any clawback will be the responsibility of the EOT trustees.
Tom Woodcock’s View:
“The worry here was that the former owner’s tax benefits are safe after ‘just’ 12 months making their commitment to the EOT quite short term. It remains to be seen if this longer period of exposure really changes attitudes amongst the tiny minority of owners who are only there for the tax breaks.”
The Government recognises some former owners may be tempted to structure so that they receive consideration above the fair market value of their shares. To prevent this potential abuse of the relief, the Government will introduce a requirement that, for a disposal to qualify for relief, the trustees must take all reasonable steps to ensure that the consideration paid does not exceed fair market value. This change will apply to all disposals on or after 30 October 2024.
Tom Woodcock’s View:
“This is sensible, and we always encourage a formal valuation for the peace of mind of all concerned.”
In addition to these changes, the Government will also require former owners to provide additional information within their self-assessment tax return. This information is intended to allow HMRC to better monitor and evaluate the relief.
Tom Woodcock’s View:
“The information required seems a bit limited if this really is the intent. It seems likely that participation in the EOT community and its membership organisations could provide a better channel for information.”
Tom Woodcock, Tax Partner
A barrister and chartered tax adviser with thirty years’ experience advising businesses on the tax implications of private company M&A, structuring, share incentives and valuation.
In the last decade, he has assisted many companies transition to employee ownership and have become a recognised expert in the field.
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