Employee Ownership Trusts

Employee Ownership Trusts

My client is a director and majority shareholder of a successful trading company (“the Company”), and as he is approaching retirement, we are discussing succession issues. The client has had many offers for his business, but he prefers not to sell to a competitor. He wants to realise a capital gain in recognition of his success but also wants to incentivise his loyal employees which also include some of his children. We are exploring an Employee Ownership Trust (“EOT”). My client wants to know if his children could also benefit from the EOT. 

An EOT is a form of indirect employee ownership which offers Capital Gains Tax (“CGT”) breaks for a vendor shareholder and income tax breaks for employees. A “classic” EOT is designed as a long-term shareholding structure where certain employees can benefit from the success of their employer company. There is also a growing number of “hybrid EOTs” which are being used to enable shares to be transferred to employees. For information on employee ownership generally, including EOT’s, see the Employee Ownership Association website.

The main reliefs from a qualifying EOT are as follows:

  • CGT relief for the client who has to dispose a controlling interest (51% or more) to an EOT (ss 236H- 236U TCGA 1992)- the share disposal disapplies the market value rule of s17 and treats the disposal as taking place on a no gain/no loss basis;
  • Relief from IHT in respect of certain transfers from and into an EOT (ss.13A, 28A and 75A IHTA 1984); and
  • Income-tax free bonuses of up to £3,600 per year to eligible employees (ss 312A- 312I ITEPA 2003).

An EOT is a complex structure and needs to be well thought through to ensure suitability before implementation. The client will need to get specialist tax advice to deal with the various conditions required to obtain the reliefs outlined above. They will also need to seek company law advice to ensure that the current constitution documents of the Company allow for shares to be sold to an EOT.

An EOT may not be suitable for the client as his children cannot benefit from the trust. This is because s.236J TCGA 1992 (the rules that permits the no gain/no loss treatment for the vendor shareholder) states that none of the settled property can be applied at any time other than for “eligible employees on the same terms”.

Eligible employees do not include “excluded participators” who are broadly anyone who has been a participator in the 10 years before property was first settled into the EOT, or a connected person of such a participator (defined in s.236J(5) TCGA 1992). Therefore, the children, as connected with the vendor shareholder, are excluded participators and so cannot benefit from the trust.

However, his children can benefit from the income tax free bonuses which are paid by the Company as employer, not the trustees. s312B ITEPA 2003 defines “qualifying bonus payments” and refers to the participation and equality requirements defined by s.312C(1) ITEPA 2003 which states:

a)the participation requirement is that all persons in relevant employment when the award is determined must be eligible to participate in that and any other award under the scheme, and

(b)the equality requirement is that every employee who participates in an award under the scheme must do so on the same terms.

 There then follows a list of exceptions from either of the above requirements being infringed. However, being a participator, or connected with one, is not an exclusion in itself- in respect of the income tax free bonuses.

If the client is still keen to proceed with an EOT he needs to accept that his children cannot benefit from the trust. Finally, the client should be aware that whilst the EOT provides various relief, it is still prone to attacks under Part 7A ITEPA 2003 and/or Transactions in Securities. As such, it is advisable, if the client is still keen on the idea of an EOT, to seek a formal clearance under s.701 ITA 2007 and a non- statutory clearance under Part 7A.

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