Employee Ownership Trusts
Professionals and business leaders have been lobbying the UK government for some time to offer a tax incentive for companies wishing to adopt the “John Lewis” model under which the company is owned by its employees, following a growing consensus backed by independent research that employee ownership offers benefits not just for employees but for businesses and the wider economy.
New legislation was finally introduced in 2014 and there are now generous tax reliefs available for companies wishing to adopt a new structure known as an Employee Ownership Trust (“EOT”).
How do EOTs work?
Broadly, the shareholders of a business will sell shares representing at least a majority stake (51%) to a newly formed trust – the EOT – which will then hold the shares for the long term benefit of the employees as a whole.
As an example assume that the company below is your average owner managed business, owned in its entirety by a single director shareholder who takes a small salary from the company each year and tops this up with significant levels of dividends.
The below diagram shows the general structure after the implementation of the EOT. The shares will now be held by the new trust for the benefit of the employees.
The EOT trustee might be a subsidiary of the company with a mixture of independent and internally-appointed trustee directors, or an independent professional trustee.
When is this structure likely to be used?
We anticipate that the structure will generally be used as a way to facilitate the exit of controlling shareholders who do not want to sell to a third party buyer, and would like to reward the existing employees by allowing them to indirectly own the business that they have helped to build.
This could be a solution for:
- Family-owned companies where the next generation are not in a position to take over running the business.
- Entrepreneurs who want to retire and realise value, but who want the business they have built up to continue on and don’t want to end up working for a new buyer at the end of their career.
- Any business where the continued commitment and motivation of all employees is key – so almost all companies should be thinking about it!
It will not however be available to non-trading investment companies or service companies.
So what are the generous tax reliefs?
The sale of the shares will be free of any Capital Gains Tax, meaning that the consideration received by the exiting shareholder(s) will be available to them in full.
Any payments from the company to the trust to fund the sale can be made on a tax free basis.
Employees of the company can receive annual bonuses of up to £3,600 per tax year, free of Income Tax (although not National Insurance).
And how will this be funded?
The EOT may be able to draw on external bank funding for the sale and we would be happy to facilitate contact with potential lenders.
Often, however, the structure will be as follows:
- The company contributes cash to the EOT which the EOT pays upfront to the exiting shareholders as part consideration for the shares.
- The EOT also issues a form of loan note to the exiting shareholders representing deferred income which can be drawn down on over a given future period.
- Each year, the company will continue to make payments out of profits to the EOT. The EOT will then use this cash to redeem part of the loan notes from the exiting shareholders.
What restrictions are there?
The EOT itself can only act to benefit all employees on equal terms. However, the company will be able to continue to make decisions on pay for its directors and employees in the normal way – the EOT will act as a shareholder, not as a substitute for the company board.
Why is this backed by the government?
The world is a changing place, and the government has recognised this. They believe that more companies should consider operating in this way and that by offering generous tax reliefs, owners may consider this as a viable option on exit.
Having employees hold a vested interest in the performance of the business can motivate staff and this in turn should contribute towards the success of the business.
If you would like to understand more about sales to EOTs and explore whether it is appropriate for you or your clients, contact William Franklin at email@example.com or call 0121 348 7878.
To find out more about EOTs, you may also be interested in William Franklin's article published in Tax Adviser on 1 April 2016, available here.