What Is An EOT? A Guide to Employee Ownership Trusts
Advice from Leading EOT Accountants
What is an EOT? An Employee Ownership Trust or EOT is a form of employee benefit trust. It offers generous tax reliefs to encourage shareholders to sell a controlling interest in their companies and promote employee ownership. EOTs were introduced by the government in 2014.
Why choose an EOT? An EOT may be useful if you, or you and a small number of family members or business associates together, own a private trading company and are considering your options for succession or retirement from the business. It could be that you are having difficulty obtaining a third party buyer, or that you wish to establish employee ownership to enable future success of the company.
Key Benefits of Employee Ownership Trust Accounting Treatment
The Buyer. Since the employees indirectly acquire the company there is no need to find an outside third party buyer, which in practice can be difficult, and may therefore resolve succession issues. Using an EOT may be many preferable to a company purchase of own shares, which requires adequate distributable reserves and has a less generous tax treatment.
The Selling Shareholders. The shareholders may retain some of their shares in the company. Although a controlling shareholding must be sold to receive the tax advantages, the shareholders may sell their shares for full market value.
Transactions Costs. Since the EOT is often a friendlier buyer, the transaction costs are usually lower and matters may proceed more quickly than with a third party buyer.
Incentivising Performance. As beneficiaries of the EOT, and potential members of a qualifying company bonus scheme, the employees are incentivised to improve the performance of the company and are more actively engaged with its operations.
How does an EOT work?
Setting up the EOT. An EOT is set up by way of an EOT trust deed. However, before the trust deed can be put in place, careful thought must be given to who the trustees will be, especially with the potential conflict of interest if a director or employee of the company is appointed as a trustee. A professional or corporate trustee could be used instead, but these can be expensive. The use of an Employee Council should also be considered (see below). We recommend taking impartial EOT tax advice from a qualified expert.
The Employee Council. Although not a requirement of the tax reliefs, it is common for an EOT to elect an Employee Council. The Employee Council is a representative body elected from the beneficiaries (broadly the employees of the company) who are empowered to appoint and remove the EOT’s trustees and in many cases must be consulted with prior to the trustees exercising their voting rights.
The Share Valuation and Share Purchase Agreement (SPA). Since the EOT will purchase a controlling share interest in the company, it will be necessary for the EOT’s trustees (and Employee Council) to agree a share price with the selling shareholders and it is likely therefore that an expert Share Valuation will need to be carried out. Once agreed, the Share Valuation will form part of the SPA.
EOT Funding. One of the key questions for any prospective EOT arrangement is; how will the EOT fund the share purchase? There are a number of potential funding methods and each must be considered on their own merits and to meet the requirements of the company’s objectives:
- Loan Funding. This can take several forms: (i) the trustees may borrow from the bank, (ii) the company may borrow money and onward lend it to the trustees, or (iii) the company may borrow money and make contributions to the EOT.
- Voluntary Contributions. Whether the company has sufficient cash deposits or takes out a bank loan, it may use these funds to make voluntary contributions to the EOT.
- Deferred Consideration. The shareholders could sell their shares on a deferred payment basis, with instalments being paid by the EOT over a number of years.
Why Choose an EOT? Tax Advantages and Requirements
The Tax Relief Requirements. In order to set up a qualifying EOT and for the shareholders and EOT to access the tax reliefs available, the company and EOT must meet a number of stringent requirements. Broadly these are:
- The Trading Requirement – the company must be a trading company or the principal company of a trading group;
- The All-employee Benefit Requirement – the property settled on the EOT must be applied for the benefit of all eligible employees on equal terms;
- The Controlling Interest Requirement – the EOT must own and continue to own more than 50% of the company’s ordinary share capital, the majority of voting rights and be entitled to more than 50% of the company’s profits and assets on a winding up; and
- The Limited Participation Requirement – Following the sale, the number of people who are both 5% participators and employees or officeholders of the company (plus the number of people who are employees and officeholders that are connected with them) must not exceed 40% of the total number of the company’s (or group’s) employees.
Capital Gains Tax (CGT) Advantages. Provided the relevant requirements are met, the EOT CGT relief may be claimed by the shareholders in respect of their disposal of shares in the company to the EOT. In addition to the requirements (i) to (iv) above, the sellers (or persons connected with them) must not have claimed the relief previously for the disposal of shares in the same company. The CGT relief operates by removing the usual market value substitution and instead the disposal is treated as a No Gain/No Loss transfer. Consequently the EOT receives the shares at their CGT base cost. The effect for the shareholders is full relief from CGT, even when the shares are sold for market value.
Inheritance Tax (IHT) Advantages. Provided the relevant requirements are met, the transfer of shares to the EOT by the shareholder will be an exempt transfer for IHT. In addition, the EOT may benefit from relief from IHT exit charges and principal (or 10-yearly) IHT charges.
Income Tax (IT) Advantages. Once a qualifying EOT has been set up and the shares in the company transferred, the company may establish a bonus scheme which, provided certain requirements are met, qualifies for a limited IT exemption on bonus payments of up to £3,600 per employee per tax year.
Disclaimer: [24th May 2023] The information in this blog was correct at the time of writing and is to be used as general guidance only. Please contact your local Hartley Fowler office for specific advice.
Hartley Fowler Services
At Hartley Fowler we seek to provide you with a comprehensive accountancy and taxation service and we work with you each step of the way. Our EOT tax advice and support services include:
- Tax advice tailored to the company, the shareholders and the EOT (once established), including in respect of the funding arrangements sought such as the use of loans, voluntary contributions or deferred consideration.
- Completing relevant tax clearance applications for submission to HMRC and negotiating with HMRC as required.
- The preparation of a company Valuation Report to help to determine the share price, assist negotiations for the sale of shares to the EOT and ultimately for inclusion in the SPA.
- Professional trustee services in respect of the EOT.
- Working closely with the solicitors, which are appointed to prepare the EOT trust deed, SPA and associated legal documents. Our EOT accountants can recommend a solicitor we have worked with to provide these services if required.
If you would benefit from EOT advice, please give your nearest local Hartley Fowler office a call.