Update on Employee Ownership Trusts (EOTs)

In our earlier update we warned that, following a change of government, we could see the full relief from capital gains tax for disposals made to an EOT being restricted or even removed. Well, as you might have seen, we did have some good news in the Autumn Statement – the current 100% relief has not changed.

However, along with many other papers published after the Budget, the government issued a policy paper  in response to the consultation process which started back in July 2023. As predicted, the government is looking to tighten up the rules around EOTs and legislation will be introduced in the next finance bill amending sections 236H to 236U of the Taxation of Chargeable Gains Act 1992.

Changes to EOTs

The changes to the conditions for qualifying for relief from capital gains tax will have effect for disposals made to an EOT on or after 30 October 2024. From that date:

• shareholder sellers or persons connected with them will be restricted from retaining control of companies post-sale to an EOT by virtue of control (direct or indirect) of the EOT. In other words, the board of the corporate trustee should have a majority of directors who are not shareholder sellers.
• the trustees of an EOT must be UK resident (as a single body of persons) at the time of disposal to the EOT. This change closes the door on using non-UK resident trustees who are not liable for capital gains tax on a subsequent sale of the company.
• trustees must take reasonable steps to ensure that the consideration paid to acquire the company’s shares does not exceed market value. We are not sure what will constitute taking “reasonable steps” and whether this means, as a minimum, the trustees should be able to produce a written independent valuation from a valuer with relevant experience of company share valuations, but even if the amendments to the legislation don’t go that far the trustees should be able to demonstrate a reasonable methodology as to how the valuation was arrived at, the assumptions used and the multiples applied.
• the ‘vendor clawback period’ of one year, within which the tax relieved can be recovered from the shareholder sellers if the qualifying conditions are breached post-sale, is extended to the end of the fourth tax year following the end of the tax year of disposal. This means that if the qualifying conditions are breached within four years, and this may include a sale of the company, then the shareholder sellers will not be entitled to the relief obtained on sale and would be taxed at the capital gains tax rate in force at the time they sold their shares to the EOT.
• shareholder sellers will be required to provide within their claim for Capital Gains Tax relief information on the sale proceeds and the number of employees of the company at the time of disposal.

In addition to the changes outlined above, further changes are proposed such that HMRC will no longer need to give clearances for EOT transactions and the EOT bonus rules will be relaxed so that bonuses can be awarded to employees without necessarily having to be awarded to directors.

Will we see a growth in EOT transactions?

With no change to the tax rate on selling shares to an EOT, and a set of proposed changes that were not unexpected, it’s likely that EOTs will continue to gain popularity as an alternative to other exit routes such as a trade sale, management buy-out or private equity transaction. This growth in the popularity of EOTs will undoubtedly be fuelled by the changes to Business Disposal Asset Relief announced in the Budget. Whilst the 10% tax rate continues until April next year on the first £1m, it will then increase to 14% in 2025/26 and to 18% in 2026/27.

Summary

Whilst not suitable for every business EOTs will be attractive for the right company. If you are considering becoming employee-owned via an EOT then taking expert professional advice is crucial to getting it right. In the last three years we have helped many companies successfully make the transition from shareholder owned status to employee owned status, and if you would like to learn more about EOTs and how we may be able to help you with your exit options, then please do not hesitate to get in touch.