Employee Ownership Trusts 'EOTs' are a useful tool for succession planning whereby a controlling interest in a trading company can be passed to the company's employees with the associated disposal being free of CGT for the vendor.
An EOT is set up with at least one trustee. The shareholders of the company sell more than 50% of the current share capital to the EOT under a share purchase agreement. The purchase price is left outstanding as a debt owed by the EOT to the vendor shareholders. The company uses its future profit to make payments to the EOT which in turn pays down the debt to the vendor. There can be a third-party financing arrangement should the vendor require the proceeds earlier than the company can create profits.
For the vendor to receive their full consideration, the company must remain profitable as it is these future profits which are used to repay the vendors debt.
The shares held by the employee benefit trust will be held by trustees acting for the employees. The selection of trustees may well be difficult, as one would be seeking those who are fully aware of their duties. While directors of the underlying company can act as trustees it is advisable to keep director trusteeships to a minimum to avoid conflicts of interest. Trustees’ obligations are prescribed by law and to a considerable extent, require the trustees to act cautiously, which may mean that they are disinclined to allow the company to borrow to any great extent and there may be other occasions when their obligations override what would be seen as normal commercial behaviour. Trustees are also exposed to personal liability, which again acts as a natural inhibitor as to their appetite for risk.
If any disqualifying events occur in the tax year the EOT acquires the shares, or the following tax year then the capital gains tax advantages for the vendor will be withdrawn and capital gain tax will be payable. If any disqualifying events occur after this period then there will be a deemed disposal resulting in CGT payable by the EOT trustees. Avoiding UK CGT in this situation could be possible by ensuring the EOT is not UK tax resident by appointing professional overseas trustees.
The trustees would normally be able to control whether a disqualifying event occurred or not. The following are disqualifying events:
All eligible employees must be able to benefit from the scheme and distributions from the scheme must be made on the same terms to all beneficiaries. However, the £ amount of any distribution can change depending on the following factors: length of service, hours worked and remuneration level. For example, you could set a bonus of £100 per year worked.
Per tax year a £3,600 bonus can be paid from the company controlled by the EOT to the EOT beneficiary free of income tax, although NIC would still be payable. Any bonus paid in excess of £3,600 would be subject to the usual payroll taxes.
It would be advisable to seek a professional share valuation ahead of such a transaction as there is no mechanism to agree a valuation with HMRC for this purpose.
IHT planning should be carried out along side the transaction for the vendor as they would be selling an asset which would likely qualify for 100% Business Property Relief for cash and/or a loan balance which would not qualify for the relief.
The EOT is considered independent for the purposes of most share incentive schemes for example EMI schemes and SIPs.
It is also possible for businesses held by partnerships to be sold to an EOT in a process that involves the partnership incorporating prior to the sale to the EOT.