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What changes are being proposed to the Employee Ownership Trusts rules and how will they affect businesses?

by Christa Humphreys

HMRC has recently opened a consultation seeking views on their proposals to reform the treatment of Employee Ownership Trusts (EOTs). This article sets out the key changes being proposed and considers the impact this is likely to have on businesses.

What is an Employee Ownership Trust?

An EOT is a trust whereby the trustees own and control a company for the benefit of all its employees. The expectation is that employee-owned companies will perform better, be more resilient and open to change and have more committed and engaged employees which in turn will drive productivity and growth.

EOTs are given tax-favoured treatment in the form of a special 100% capital gains tax relief for individuals who sell their company shares to the trustees, an exemption from inheritance tax on the transfer of shares to the EOT and an income tax relief on qualifying bonuses paid to employees and directors of up to £3,600 per year per employee.

Our earlier article gives more detail about EOTs and the tax implications of a shareholder sale.

Why are changes to EOTs being proposed?

The government is concerned that the EOT rules are being abused by some businesses. They say the aim of the proposed changes is to ensure that the EOT tax regime remains focused on rewarding employees and encouraging employee engagement. They also wish to prevent tax advantages being obtained by former company owners where there is no genuine increase in employee engagement.

What are the changes to EOTs that are being proposed?

Fortunately, no changes are being proposed to the types of relief available, but the aim is instead to tighten up and clarify some of the existing rules to prevent them from being exploited. The proposed changes are:

1. Former owners will be prevented from having control of the EOT trustee board

The EOT trustee board controls the company because it has a controlling shareholding. Currently there are no rules dictating who can be on the trustee board and, in some cases, former owners have been appointed to the majority of board seats, meaning that they have not effectively relinquished control of the company. There is concern that this has given them an unfair tax advantage because, whilst they have disposed of their shares in the company tax- free to the EOT, they have not in reality ceased to control it.

Therefore, it is proposed that a new rule is introduced requiring that the former owners (together with their ‘associates’) make up less than half of the EOT trustee board. ‘Associates’ include spouses, civil partners and close relatives. This will mean that former owners will no longer have the opportunity to control the company, although they will still be able to be involved.

The government is also considering whether these rules should be tightened further, for example by requiring employees to be included on the trustee board. They believe that this would help to ensure employees’ interests are represented adequately on the board. However, they do acknowledge that this may reduce the flexibility to tailor the EOT board to meet the circumstances of the company.

2. The EOT will be required to be UK resident

Currently, an EOT can be non-UK resident. This is established by appointing solely non-UK resident trustees to the EOT board. An EOT can therefore be non-resident even if the company, the employees and the former owners are all UK resident.

Non-UK resident EOTs do not pay capital gains tax when they eventually dispose of the shares in the company. The government believes that some businesses have appointed non- UK resident trustees solely as a means to obtain a tax advantage rather than for genuine commercial reasons.

The proposal is therefore to introduce a requirement that the EOT trustees are UK resident as a ‘single body of persons’. It will still be possible for the EOT board to include some (but not all) non- UK resident trustees, as there may be legitimate business reasons for doing so, but the EOT itself will remain UK resident. This would ensure that any future disposal of shares by the EOT remains within the charge to UK tax.

Does the consultation document recommend any other adjustments to the legislation?

The government also proposes to provide clarity to businesses on a few ‘grey areas’ where advisers have previously needed to apply to HMRC for clearance as to the tax treatment. These are:

  • Confirmation that monies received by former owners from the EOT in payment for their shares will not be charged to income tax, provided that the overall consideration does not exceed market value.
  • Confirmation that contributions by the company to the EOT will not give rise to a ‘S455’ corporation tax charge on the company.
  • Relaxation of the rules regarding the £3,600 tax free annual bonus, so that these can be awarded to employees without directors necessarily also having to be included.

How will this affect businesses?

Although the newly proposed rules may create slightly more hurdles for businesses setting up EOTs, we do not expect they will have a significant impact for the majority of our clients. The consultation simply aims to make clear in law what has always been its intention and, in our opinion, has always been best practice.

The clarifications given, regarding EOT contributions and payments to former owners, are a welcome step forward. Nevertheless, we expect that our clients will still want to apply to HMRC for advanced clearance before adding an EOT to their corporate structure, to obtain confirmation that capital tax treatment (and therefore the lower capital tax rates) will apply on a disposal of shares to the EOT. Applying for clearance is still very much standard practice whenever a business owner plans to extract significant value from their business (including, for example, by means of share buybacks and management buy-outs) and will remain advisable once the new rules have been implemented.

One area that is currently unclear is whether the changes will affect EOTs that are already established. We assume that only new arrangements will be targeted but note that this is yet to be confirmed.

Get in touch

At Rickard Luckin we regularly help businesses to implement EOT structures. These can be a very effective and tax efficient way of enabling a shareholder exit, whilst simultaneously encouraging the future growth of the company by engaging and incentivising employees. If you would like to find out more about EOTs please get in touch.

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