Recent changes to EOTs

A topic that failed to make Rachel Reeves’ Autumn Budget announcement on Wednesday 30 
October was the changes to employee ownership trusts (EOT).

The EOT legislation seeks to promote employee ownership and encourage individual 
shareholders of trading companies to sell a controlling interest to an EOT. An EOT is a trust 
which holds all its assets for the benefit of the employees of the relevant company.

EOTs as an exit rout

An EOT sale can be an attractive and extremely tax efficient sale structure for individual shareholders of trading companies, especially where there is no obvious third-party purchaser. An EOT sale can be financed by the company’s cash reserves and future profits, or with third party lending.

If structured correctly and the relevant conditions are satisfied, the sale will not trigger any capital gains tax for the sellers, resulting in a tax-free sale. Further, there is an exemption from income tax on bonus payments of up to £3,600 per year made to employees by companies owned by EOTs.

Key Conditions

The tax reliefs described above are subject to a number of conditions, including:

• The EOT must use its assets for the benefit of all eligible employees of the company. This must generally be done on the same terms but the legislation allows the EOT to differentiate between employee entitlement based on
  1. remuneration;
  2. hours worked or
  3. length of service.
• The number of continuing shareholders who are directors/employees (and their "connected persons") must not exceed 40% of the total number of employees.
• The company being sold must be a trading company.
• The EOT must acquire more than 50% of the ordinary shares in the company. It must also have more than 50% of the voting power when it comes to any matter relating to the company.

Autumn 2024 budget changes

The following additional requirements were introduced, effective from 30 October 2024:

1: The trustee independence requirement

• This was introduced in order to limit the seller's involvement and control post an EOT sale. Going forwards, more than 50% of the trustees the EOT (or directors of a corporate trustee) must comprise of persons who are not sellers or shareholders.
• Importantly, the legislation specifies that the sellers/shareholders cannot have control of the EOT 'settlement'.
• Although the legislation is open to interpretation, the prudent approach would be to ensure that the sellers cannot, alongside connected persons, control the board of the company, as well as the trust board (as previously required). The need for appropriate seller protection for any deferred consideration is therefore brought into further focus.

2: Valuation requirement

• The EOT trustee must now take all reasonable steps to ensure that the consideration does not exceed market value at the time of the sale; or where some or all of the consideration is deferred, the rate of interest (if any) payable does not exceed a reasonable commercial rate.
• Arguably, this has little practical effect as, even before the changes, a sale for over market value would result in tax charges for the selling shareholders. However, the new condition emphasises the importance of an independent valuation being sought.

3: Trustee residency

• The trustees of the EOT must be UK tax resident. This prevents the EOT structures which use a trustee incorporated in a low tax jurisdiction with the aim of avoiding CGT on a future sale by the EOT,

In addition, the period in which HMRC may withdraw EOT relief in the event of a breach of the above conditions has been extended to four years.

Importantly, the proposed legislation addresses a deficiency in the previous legislation which did not make clear that company funds contributed to the EOT to pay the purchase price would be tax free (HMRC clearances were normally sought to confirm this point). The practical effect of the change is that most EOT transactions will no longer require HMRC clearance. However, where company funds are contributed to the EOT to fund the purchase price, a claim for relief will need to be made.