Employee Ownership Trust

What is an Employee Ownership Trust (EOT)?

An EOT allows a business to be owned by its employees and is generally set up by a company’s existing owners as part of an exit or succession plan. There are some attractive tax incentives available for the owners, and it remains a real alternative to a trade sale.

Introduced in 2014, EOT’s have increased in popularity particularly over the last couple of years, with over 1,000 now in existence. We explore the benefits, the requirements, and the route to employee-ownership in this article.

What are the benefits of an EOT?

To the business owner:

  • The disposal of 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.
  • Value created within the business can be realised whilst retaining leadership and business culture, which can be at risk from a trade sale.
  • Business owners can feel a real sense of legacy, and peace of mind that the business is in good hands.

To the business:

  • Employee-ownership has been evidenced to achieve increased productivity and results, due to employees having part ownership of the business and a personal commitment to its long-term success.
  • Business value and culture is preserved, so there is less risk of reputation change associated with a trade sale.

Helps develop innovation, thereby creating a more resilient business.

Benefits to the employees:

  • Employees obtain their interest in the company without the need to make any financial investment.
  • The ability to influence decisions on company policy and strategy tend 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 payable to all and on the same terms.

Does your business meet the criteria for an EOT?

An EOT must meet the following criteria in order for the seller to qualify for full relief against capital gains tax:

  • The business must be a limited company which falls within the definition of a trading company (or the holding company of a trading group) for tax purposes. This means that any non-trading activity must not exceed 20% of the whole, based on several criteria, 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 does not mean that all employees must be on the same remuneration – that is a decision for the business.
  • The EOT must not hold a controlling interest in the company before the transfer but must hold a controlling interest after the transfer takes place.
    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 hold 5% or more of the company must not exceed 40% of total employee numbers.

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

  • The trading employer company must have had an EOT holding a controlling interest for at least 12 months.
  • There is a maximum limit of £3,600 income tax free bonus per employee per tax year
    All employees participating 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.
  • The payment must not consist of normal salary.
  • The company cannot have more than 40% of the total employees and directors, as directors of the company.

The route to employee-ownership

Generally, the most time-consuming part is ensuring that this particular ownership strategy is right for the business owner, the business, and the employees. There may be different ways to achieve the same goal, and we have extensive experience working through different succession planning options.

If it is agreed to move forward with an EOT, in broad terms the steps are as follows:

  1. Agree the design of the EOT. Will it own 100%, 51%, or somewhere in between? Over what timeframe will the consideration/value be paid? What sort of role will the sellers have in the company? Who will be Trustees of the EOT?
  2. Value the company and clear the transaction with HMRC.
  3. Legal drafting of sale agreement, EOT set up and relevant share transfer forms.
  4. Communication with senior leadership and employees.
  5. Trustee appointments and establishing the EOT.
  6. Execution of share purchase agreement.

Alongside determining whether an EOT is the right strategy, we can also advise on the valuation of the company. It is also more common to raise bank loans to pay off previous owners completely, which would usually 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.

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