The legal concept of an Employee Ownership Trust (EOT) structure was introduced by the Finance Act 2014. The government’s aim was to promote more sustainable and diverse ways of running a business in the UK through the encouragement of employee ownership. It has long been part of the agenda in the UK to increase employee participation in UK businesses and employee share ownership has formed part of this discussion.
How do they work?
EOTs are collective vehicles which purchase the shareholding in a trading company and then hold it on behalf of the employees as a whole. The shareholders of a company (i.e. the owners) sell shares representing at least a majority stake (51%) of the equity of the company to a newly formed trust (i.e. the EOT), which will then hold the shares for the employees. Essentially, EOTs are a new form of an employee benefit trust to effect direct employee ownership.
By giving employees access to a direct stake in the business they are working for, it is anticipated that they will feel more engaged and committed to the success of the business beyond the ‘performance’ based share options that are traditionally used. This should translate into improved productivity and profitability for the company with long term goals in mind.
How would this look
There are ways you can effectively structure the transfer to the EOT to ensure the best outcome from a cash flow perspective. For example, if you can structure your operations to retain distributable profits (rather than paying them out as dividends) prior to the transfer to the EOT, part of the Purchase Price can be paid shortly after Completion on a tax free basis.
To promote the EOT structure the government introduced generous tax breaks where all of the detailed conditions are satisfied to incentivise companies to move to EOT structures. In particular:
- An income tax (IT) exemption of £3,600 per tax year on certain bonus payments issued to all employees. National insurance contributions do not fall within this exemption
- A full capital gains tax (CGT) exemption when a majority of shares (at least 51%) in a company are sold to the EOT. As such, no CGT liabilities arise for the owners
- A relief from inheritance tax on certain transfers into and from EOTs
EOTs allow employees to acquire a controlling ownership of the company from its existing shareholders without having to use their own funds. Owners are increasingly considering the EOT structure to deal with succession issues where traditional trade sales or management buy-out routes are not currently available.
EOTs provide an opportunity for owners to preserve the legacy by selling the business to their staff. As well as creating an immediate purchaser, EOTs are generally seen as a ‘friendlier purchaser’ too, meaning the company can benefit from a quicker sales process and lower fees.
The concept of an EOT is relatively straightforward. As ever, however, the devil is in the detail and great care must be taken to ensure that all of the conditions are satisfied so that the tax reliefs outlined above are available.