Employee Ownership Trust

What is an Employee Ownership Trust (EOT)?

An EOT is where the business is owned by the employees and is usually set up by the existing owners as part of an exit or succession planning. Often an EOT is set up using an employee benefit trust which provides a framework for employee ownership. This structure gives tax advantages and employee engagement by way of indirect ownership and management for employees through trusts. There are some great tax benefits for the owners, including avoiding paying capital gains tax, and it’s a real alternative to a trade sale.

Launched in 2014 EOT’s have grown in popularity over the last couple of years with now over 1,000 in existence. We look at the benefits, the requirements and the route to employee ownership in this article.

What are the benefits of an EOT?

To the business owner:

• Selling shares to the EOT can leave the seller with no tax to pay as long as the EOT ends up with a controlling interest (more than 50% ownership) in the company. This is compared to business asset disposal relief (BADR) where selling a business incurs capital gains tax (CGT).

• Value can be extracted from the business without losing leadership and culture which can be at risk with a trade sale.

• Making sure the sale is at market value is key to avoiding tax issues and legitimacy. An independent valuation will help the seller and the trustees.

• Business owners can feel a sense of legacy and peace of mind that the business is in good hands.

To the business:

• Employee ownership has been proven to deliver increased productivity and results as employees have part ownership of the business and a personal stake in its long term success.

• Business value and culture is preserved so less risk of reputation change with a trade sale.

• Helps to develop innovation so a more resilient business.

Benefits to the employees:

• Employees get their interest in the company without having to invest any of their own money.

• Ability to have a say in company policy and strategy tends to lead to more motivated employees with a clear shared purpose.

• Employees can receive tax free bonuses of up to £3,600 per annum as long as they are paid to all and on the same terms.

Is your business an EOT?

An EOT must meet the following criteria for the seller to get full relief from capital gains tax:

• The business must be a limited company which is a trading company (or the holding company of a trading group) for tax purposes. This means that any non-trading activity must not be more than 20% of the whole based on several factors such as turnover, profit and time spent.

• If the EOT provides benefits such as bonuses to individual employees it must do so on the same terms for all eligible employees. This doesn’t mean all employees must be on the same remuneration – that is for the business to decide.

• The EOT must not have a controlling interest in the company before the transfer but must have a controlling interest after the transfer. There are additional rules where a transferor has an interest of 5% or more in the company in the 12 months before transfer of shares to the EOT. The requirement is that the number of employees who have 5% or more of the company must not be more than 40% of total employee numbers.

Income tax relief on bonuses paid to employees of companies controlled by an EOT must follow the below:

• The trading employer company must have had an EOT with a controlling interest for at least 12 months.

• Maximum limit of £3,600 income tax free bonus per employee per tax year All employees in the arrangement must be treated equally except if they have less than 12 months continuous service and awards can be flexed by reference to pay, length of service or hours worked.

• Must not be normal salary.

• Can’t have more than 40% of the total employees and directors as directors of the company.

How Employee Ownership Trusts Work

An Employee Ownership Trust (EOT) is a special structure that allows a company to transfer a controlling interest to its employees, effectively an employee buyout and to create a sense of ownership and engagement. Here’s how it works:

• Setting up the EOT: The company sets up an EOT, a separate legal entity that holds the shares on behalf of the employees.

• Transferring Shares: The company transfers a controlling interest in the business to the EOT. This means the EOT must hold more than 50% of the company’s shares.

• Beneficiaries of the Trust: The employees become beneficiaries of the trust, they gain indirect ownership of the company without having to invest their own money.

• Managed by Trustees: The EOT is managed by a board of trustees who make decisions in the best interests of the employees. These trustees can include employee representatives so the workforce has a say in the direction of the company.

• Employee involvement: Employees can influence company decisions through their representatives on the board of trustees, creating a culture of transparency and shared purpose.

The EOT can hold up to 100% of the company’s shares, it’s a flexible and tax efficient way for business owners to transfer ownership to their employees. This structure also preserves the company’s culture and values.

Funding an Employee Ownership Trust

Funding an Employee Ownership Trust (EOT) can be done through various funding options, each with its own pros and cons. Here are the main funding options:

• Cash Consideration: The company can pay cash into the EOT to fund the purchase of shares. This gives immediate liquidity to the selling shareholders.

• Vendor Loan: The selling shareholders can lend the EOT the money to buy the shares. This loan is repaid over time from the company’s profits.

• Bank Loan: The company can borrow from a bank to fund the contributions to the EOT. This may involve regular repayments and interest but will provide the necessary capital to complete the transaction.

• Deferred Consideration: The purchase price can be paid in instalments over time. This allows the EOT to spread the cost of acquisition making it more manageable.

Careful planning and implementation of the funding structure is key to avoid any tax traps. A professional valuation of the company is required when setting up the trust and transferring ownership. This valuation must be defensible by an independent expert and relied upon by the trustees to ensure fairness and tax compliance.

By choosing the right funding and a good valuation process business owners can transition to an employee owned model and benefit the company and employees.

The employee ownership route

The most time consuming bit is usually to make sure this employee share ownership strategy is right for the business owner, the business and the employees. There may be different ways to get to the same end, we have experience of working through different succession planning scenarios.

If we go ahead with an EOT the steps are:

• Agree the EOT design. Will it own 100%, 51% or somewhere in between? Over what period will the consideration/value be paid? What role will the sellers have in the company? Who will be the Trustees of the EOT?

• Value the company and clear with HMRC.

• Legal drafting of sale agreement, EOT set up and share transfer forms.

• Communicate with senior management and employees.

• Trustee appointments and EOT set up.

• Execute share purchase agreement.

As well as whether an EOT is the right strategy we can also value the company. It’s also more common to borrow from the bank to pay off previous owners completely which would be paid over a longer period of time.

For more information on Employee-Ownership Trusts, please contact our Business Services team on info@plusaccounting.co.uk or 01273 701200.

Want to learn more?

Get in touch with our in house expert Jake Standing to see how we can help.