Employee Ownership Trusts (EOTs): How to achieve a low-tax business exit
In light of current and recent events, we are seeing an increase in clients asking about how business owners can achieve an exit while benefitting from the current, relatively low, CGT rates.
One potential exit route with very attractive tax consequences for sellers is a sale to an Employee Ownership Trust (EOT).
If structured correctly, a sale of a controlling interest to an EOT is tax-free for sellers and, as it is seen as a "friendly" sale, completion of the sale process may be quicker than a traditional trade sale.
What is an EOT?
An EOT is a corporate ownership structure whereby a controlling shareholding of the company is held by trustees of a trust specifically set up for that purpose. The trustees are bound by the terms of the trust to apply their control of the company for the benefit of all the employees of the company.
Typically, the trustee will be a subsidiary of the company, with directors of the company often also acting as directors of the trust company. It is not uncommon for sellers who retain a shareholding in the company to act as directors of the trust company post-sale.
What are the key benefits for sellers of selling to an EOT?
• It allows an exit where there is no obvious third-party purchaser.
• It allows a tax-free disposal, with a full capital gains tax exemption on the disposal proceeds, and no income or inheritance tax liabilities.
• Directors can remain with the company post-sale and continue to hold a minority shareholding and/or receive remuneration via service contracts.
• Not all shareholders are required to sell and share capital can still be available post-sale to incentivise key employees.
• The process is often quicker than a sale to a third party, with potentially lower transaction fees.
What are the key conditions?
• The EOT must have a controlling interest in the company (i.e. it must acquire more than 50% of the shares).
• The EOT must be established for the benefit of all employees (excluding, broadly, individuals who hold or who have previously held more than 5% of the shares).
• It must treat all employees on an equitable basis.
In addition, there is a specific qualifying condition which may preclude small family- run businesses from qualifying, called the "limited participation" rule. Broadly, each individual who holds 5% or more of the shares in a company is a "participator", and if participators make up more than 40% of the workforce, the company will not qualify.
How is the sale financed?
The sale of shares to an EOT is usually financed through a loan from the outgoing business owners, which is usually repaid in instalments from the future profits of the business, or from third-party financing.
Benefits for employees
• Employees can receive annual tax-free cash bonuses of up to £3,600 per employee per year.
• Employees can receive share-based incentive awards.
• Employees have a stake in their company, potentially resulting in greater employee engagement, commitment and retention.
Any downsides?
• Any loans made to the EOT to finance the purchase will need to be paid back from profits and repayments can be a drag on profitability.
• The sale will be at fair market value, and sellers may achieve a better price on the open market.
• If the company fails to meet the conditions for an EOT following the sale, it can have adverse tax consequences for the selling shareholders (if the conditions are not satisfied in the first 12 months post-sale) or the trust (if the conditions are not satisfied after that time).
About the author
Charles Goddard is a tax solicitor with over 25 years' experience of advising on the corporate tax aspects of a wide range of corporate and financial transactions. His clients range from multinational blue-chip institutions to private individuals.
Find out more about Charles and our corporate tax advice and consultancy services for business.
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