Business Owners
An Employee Ownership Trust (EOT) is a structure that enables businesses to be owned by their employees while offering significant tax advantages to the founder or shareholder selling the company. When the relevant conditions are met, the sale is treated as occurring on a nil gain/nil loss basis for capital gains purposes. This offers better tax benefits than the Business Asset Disposal Relief (BADR), which is currently taxed at 10%, but is set to increase to 14% from April 2025 and to 18% from April 2026.
Under an EOT arrangement a trust is established to hold the company shares on behalf of the employees. Trustees, typically including employee representatives and the founder shareholder(s), are appointed by the trustee director to manage its affairs.
Key Benefits of EOT
Tax-Free Bonuses: the EOT can pay bonuses of up to £3,600 per year to employees without attracting any tax, although employer National Insurance contributions are still due.
Improved Business Performance: studies show that employee-owned businesses often perform better, driving innovation and profitability. This is because employees are more motivated and committed when they have a stake in the business.
Advantageous for Minority Shareholders: minority shareholders who might not meet the minimum interest requirements for BADR can benefit from the EOT structure.
Friendly Transaction: since no external parties are involved, the transaction is typically seen as a "friendly" one, making negotiations easier and more collaborative.
Higher Return for the Seller: with no capital gains tax (CGT) involved, the seller can receive a higher overall return compared to a traditional sale.
Key Risks of EOT
Deferred Consideration: one of the main risks is that a large portion of the sale price may be deferred. The seller becomes reliant on the company’s future trading performance and profitability to ensure the payment of deferred consideration.
Loss of Control: by selling at least 51% of their shares, the seller loses control of the company. The seller must rely on the company’s directors and the trustees of the EOT to act in the best interests of the business.
Conditions for EOT Eligibility
For a company to qualify for an EOT, the following conditions must be met:
The company must be a trading company.
EOT trust must hold more than 50% of the company’s shares.
All employees must have the opportunity to benefit from the EOT. Employees with less than 12 months of continuous service can be excluded and employees with a past or present 5% or greater interest in the company are ineligible.
The terms of the EOT must be the same for all employees.
Employees who hold 5% or more of the company’s shares cannot represent more than 40% of the total workforce.
Disqualifying Events
Certain events can disqualify the company from receiving EOT benefits, which can impact both the seller and the EOT, which include:
The EOT selling any of its shares, thus losing its controlling interest.
Employees holding more than 5% of the company’s shares representing more than 40% of the workforce.
Unequal terms being awarded to employees, breaching the requirement of equality.
The company ceasing to be a trading company.
Effects of Disqualifying Events
If a disqualifying event occurs within four tax years of the disposal, Capital Gains Tax (CGT) relief for the seller will be withdrawn. CGT will then apply to any gains accrued at the time of the original sale.
Speak to an Expert
An EOT can be a very beneficial option for founder shareholders, offering significant CGT relief and a smoother sale process. If you're considering an EOT or want to learn more, please reach out to our tax team for expert advice and assistance.
Authored by: London Tax Team
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