EOT – Employee Ownership Trust
Employee Ownership Trusts (“EOTs”) are becoming an increasingly popular way for business owners to transfer ownership of their companies to their employees. The UK Government introduced several tax incentives for EOTs in 2014, including a 0% Capital Gains Tax (“CGT”) rate on the sale of shares to an EOT but many people are still unaware of this tax break, which could save them a significant amount of money. Today there are almost 300 companies a year transitioning to employee ownership (source EOA https://employeeownership.co.uk/resources/what-the-evidence-tells-us/).
To understand the benefits, it is first important to understand what an EOT is. An EOT is a type of trust that is designed to hold shares in a company on behalf of its employees. The trust is established by the business owners, who sell some (minimum 51%) or all of their shares to the trust. This can be financed by a mixture of spare cash in the company, third-party debt and vendor loans over a period of time. The vendor loan locks in the 0% tax at today’s rate thereby allowing what is potentially dividend income to be paid as capital at 0% CGT. It is very important, however, that the driver for an EOT is not the tax benefit and that the trust is established properly with a full change of control to the employees for at least three years. Following the transfer of control, management will sit centre stage running the business for the benefit of the employees overseen by the trustees to ensure that the business is being run for the benefit of the employees.
Whilst tax should not be the driving force for an EOT, it is a great incentive, but there may be a small window of opportunity to enjoy it. Whilst the UK’s main political parties support employee ownership, the 0% rate is very favourable to the usual 20% CGT rate on the sale of shares on Mergers and Acquisitions (“M&A”) transactions. Additionally, with the next general election occurring before January 24th 2025, the majority of voters support a raise in CGT (source: YouGov January 2023), with 41% for an increase and 30% against. Conservative voters tend to be opposed to an increase and Labour voters are supportive. Therefore, if there is a change to a Labour Government, given that the standard 20% CGT rate on M&A is very favourable compared to income tax, it is likely to be increased. In turn, therefore, it is difficult to see how the 0% CGT rate on EOTs could survive – no matter how much the political parties support employee ownership. The window of opportunity to secure 0% CGT on an EOT structure may be diminishing.
0% CGT – Capital Gains Tax
To conclude, the 0% CGT rate on EOTs is a valuable tax break that many business owners are still unaware of. By setting up an EOT, business owners can transfer ownership of their company to their employees, with legitimate rewards and benefits from significant tax savings. Structured correctly, employee-owned businesses should be more productive and invest for the long-term – thereby actually generating more tax for the Government, not less.
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