Employee Ownership Trusts (EOTs) are gaining popularity as a sustainable, tax-efficient way for business owners to transition ownership while safeguarding employees’ futures. As we navigate the 2024/25 tax year, understanding the financial and tax implications of EOTs is crucial, especially given the changes announced in the Autumn Budget 2024.
What is an Employee Ownership Trust?
An Employee Ownership Trust is a structure that enables a company to be owned by its employees, indirectly, through a trust. Rather than individuals or external investors holding shares, a trust holds them on behalf of employees.
The main appeal of an EOT for vendors is that it allows them to sell or transfer the company to employees whilst often remaining involved, thereby ensuring a smooth transition. For employees, it fosters a sense of ownership and long-term commitment, often leading to a more motivated workforce.
Tax benefits of EOTs
The tax advantages of EOTs under UK law are a significant draw, offering benefits to both sellers and employees. This is especially attractive for small and medium-sized businesses.
- Capital gains tax (CGT) exemption for sellers
Business owners selling a controlling interest (at least 51%) to an EOT may qualify for a CGT exemption. This applies if specific HMRC conditions are met, including the requirement that the EOT holds a controlling stake in the business post-sale. With the recent CGT rate increases announced in the Autumn Budget 2024, the tax savings from this exemption have become even more significant. As of 30 October 2024, the CGT rates on assets (excluding residential property and carried interest) have increased from 10% to 18% for basic rate taxpayers and from 20% to 24% for higher rate taxpayers. For business owners selling to an EOT, the exemption from these higher rates can represent a substantial tax saving, especially for valuable businesses. The updated rates create a more substantial financial incentive for business owners to consider an EOT, as selling through this structure allows them to avoid these increased CGT liabilities entirely, provided they meet HMRC’s conditions.
- Income tax-free bonuses for employees
EOT-owned companies can pay tax-free bonuses of up to £3,600 per employee annually, allowing companies to reward employees efficiently while they share in the company’s success. Although these bonuses are subject to National Insurance Contributions (NICs), the income tax relief itself significantly boosts employees’ take-home pay.
Financial considerations for business owners
While EOTs offer tax benefits, business owners must carefully assess the financial implications.
EOTs generally base their sale price on a valuation report. The value is then agreed with HMRC via ‘tax clearance’.
Valuation and funding the sale
EOTs typically finance share purchases with a loan from the operating company, requiring future profits to cover repayment, potentially impacting cash flow whilst the loan is repaid.
Additionally, EOT companies may establish long-term employee incentive schemes to uphold motivation, which carries its own costs.
Legal and governance considerations
Setting up an EOT entails specific legal and governance requirements. Upon transferring control to an EOT, the trust must act in employees’ best interests, which can affect decision-making processes.
- Trustee board
An EOT requires a trustee board to manage the trust. While former owners may remain involved, the board has a legal duty to operate for the benefit of all employees. This often involves appointing independent trustees and employee representatives. - Employee involvement
Although employees do not directly control the business, they gain a voice in its operation, typically through the trustee board. Many companies also create employee councils or representative bodies to enhance engagement.
Recent developments and best practices
The Autumn Budget 2024 reaffirmed support for employee ownership, with EOTs continuing to benefit from favourable tax treatment. However, owners should remain alert to potential changes in business taxation and employee benefits regulations, which could impact EOTs.
For best practice, consider how technology can aid the transition. Tools for managing employee communications, real-time financial reporting, and governance are now more advanced, helping ensure a smoother transition.
You can review the new government changes or seek advice from us – we’re just a call or email away.
Is an Employee Ownership Trust right for your business?
Determining whether an EOT suits your business depends on factors like financial health, long-term goals, and employee engagement. EOTs allow owners to preserve their company’s legacy and reward employees, but they come with specific financial and legal responsibilities.
If you’re exploring whether an EOT could be a good fit, our team is here to help. With extensive experience in guiding businesses through this transition, we offer tailored advice to suit your needs and our employee share ownership trust valuations. Contact us today.
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