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Employee ownership Trusts - An alternative Exit
19 March 2020
From April 2014, the Government made available a new form of trust, an Employee Ownership Trust (EOT). Which came with a host of attractive reliefs. This new form of trust came from an earlier promise to further investigate employee focused incentives, in a bid to assist companies in the recruitment, retention and motivation of staff.
Whilst an EOT comes with clear benefits and incentives for employees whose companies have implemented them – which we’ll explore, an EOT can also provide a very viable alternative for business owners. Especially for those looking to exit where there is no family succession planned and/or they do not want to sell out to a third party buyer.
Capital Gains Tax (CGT)
TCGA 1992 was amended to allow disposals of shares to go into EOT. This benefits all employees and leads to a controlling interest in a company being held by the trust. Which will be treated as a disposal made at ‘nil gain nil loss’ completely exempting the sale from CGT.
Such a relief may be an attractive proposal for many shareholders to consider implementing an EOT; however, the following conditions must be met for a company to qualify:
- The shares in question must be held within a trading company, or the parent company of a trading group.
- The trust which obtains the shares must operate solely for the employees (beneficiaries) benefit and trust property must be applied to all eligible employees on the same terms.
- The trust must have a controlling interest in the company by the end of the tax year. An interest which it did not possess at the beginning of that tax year.
- The taxpayer/claimant must not have previously qualified for any other relief on the same company shares (i.e. Entrepreneurs Relief).
- Certain participants will be restricted from being beneficiaries of the trust.
A CGT exempt sale potentially provides an even more efficient exit than a sale, when including the benefit of entrepreneurs’ relief, particularly now the lifetime limit has been reduced to £1m. Financing the sale will form a large practical hurdle to clear, but it may simply require that the payment is staged over a longer period, allowing the company to generate sufficient excess cash to fund the trust, and to allow the departing shareholder to be paid off. With the disposal being exempt from CGT, the former shareholder will not have an impending CGT bill to be concerned about.
An amendment of the ‘Income Tax Earnings and Pensions Act‘ (ITEPA) 2003, allows bonus payments of up to £3,600. This would otherwise have been taxed under PAYE, to be paid to employees without giving rise to IT charges. While companies will have the discretion to set bonuses as they see fit under an EOT, there are, once again, conditions attached to this relief, in that the bonus payment must be a bonus and not form part of the employees’ regular salary or wage. Furthermore, there cannot be any arrangement whereby the employee forfeits some of their rate of pay or salary in return for a bonus payment.
Clearly not wishing to be too generous, there is only one exemption from IT and not national insurance contributions on these bonuses. Therefore any amounts paid would still be subject to Class 1 Primary and Secondary contributions.
Inheritance Tax (IHT)
Section 86 Inheritance Tax Act (IHTA) 1984, sets the conditions for IHT for an ordinary employee benefit trust to not be treated as relevant property, incorporating the provisions to ensure an EOT is also not treated as relevant property for IHT. Not being relevant property means that the trust assets escape the normal principle and exit IHT charges applied to trusts.
Corporation Tax (CT)
The tax free bonus payments made to employees will represent ‘qualifying benefits’ under the employee benefit contributions rules set out in CTA 2009. This ensures that the payments will afford the employer company a CT deduction for the payments.
In line with the Nuttall review of employee ownership, the intended results of such a trust are that employees become incentivised, motivated to work hard and contribute to the company’s future success. The arrangement effectively helps to align the interests of the company’s shareholders and the employees, allowing focus to be shifted to increasing the productivity and profitability of their company.
For the exiting shareholders, an EOT presents an additional exit opportunity, which is both relatively straight forward when compared to a sale on the open market and is likely to be low cost from a fees and tax perspective.
You may have already claimed Capital Allowances tax relief, but have you considered everything possible?