Employee Ownership Trusts: Recent Legislative Changes

The UK Government proposes updates to legislation to tighten the Employee Ownership Trust tax regime and ensure EO remains viable and sustainable.

In response to the consultation (Taxation of Employee Ownership Trusts and Employee Benefit Trusts which ran from 18 July 2023 to 25 November 2023) the UK Government published it's summary of responses alongside the Autumn Budget 2024.  You can read the full response and the draft legislation here. 

The response sets out a series of legislative updates which are included in the draft Finance Bill 2024-2025, which is currently making its way through Parliament (on its second reading at the time of this article).  Once the relevant changes go live, assuming there are no changes during the passage of the Finance Bill through Parliament, the amendments to the Employee Ownership tax regime will come into effect and, for the most part, will have effect from 30 October 2024 (so will look back slightly but are not intended to be fully retrospective for completed EO transitions). 

Largely, the changes are to codify the existing best or recommended practices within the EO sector and we therefore do not expect that we will be changing how we advise our clients and how we structure transitions to employee ownership.  We have summarised the key changes below. 

UK Residency Requirement for EOT Trustees

A new relief requirement (for the relief from capital gains tax on a disposal to a qualifying employee ownership trust ("EOT")) is being added which requires the trustees of the EOT must be, and should remain, UK resident.

This is already in line with best practice and we don't advise our clients to establish an offshore trust. 

EOT Trustee Independence Requirement

A new trustee independence requirement, which is already strongly advised as best practice, means that more than half of the trustees must be independent of the sellers (usually these will be the employee trustees, management trustees unconnected with any sellers and your independent trustee(s)).

This restricts sellers, and any persons connected with the sellers, from being anything more than a minority of the EOT trustees.

Market valuation of the shares

EOT trustees will be required to take all reasonable steps to ensure that the consideration (the purchase price) that the EOT pays to the sellers for the shares in the trading company does not exceed the market value of those shares at the time of the sale.  The same principal will also apply if any interest is payable on any deferred element of that, which must be no higher than a "reasonable commercial rate".

It is already our standard practice, and best practice int eh sector, to advise that an independent valuation of the business is obtained by the trustees. 

Extension of period for disqualifying events

Previously the relief from capital gains tax for the sellers was open to disqualification if certain events occurred in the tax year following the tax year in which the sale to the EOT was completed.  This is now being extended to the first four tax years following the disposal year.

There are two principal disqualifying events which will be of concern to sellers (though there are others).  The first being the sale of any shares in the trading company by the EOT which brings the EOT shareholding below 51% (the qualifying threshold) or if the trading company ceases to trade (i.e. begins an insolvency process). 

Additional information for CGT relief claims

Sellers should be aware that when claiming relief for the capital gains tax in their individual tax returns there will now be a requirement to provide some additional information on the sale itself, including the number of employees at the company at the time of the sale and the amount paid for the shares.

This will apply to any sellers who sold their shares to an EOT after 04 April 2024. 

Income tax free bonuses & directors

A trading company which has a qualifying EOT as a shareholder can continue to make income tax free bonus payments to employees, but will now be able to exclude directors from those payments, if that is desirable, without prejudicing the tax relief for the employees. 

No More HMRC Clearance for EOTs

To date it has been standard practice during an EO transition to obtain clearance from HMRC that the payments made by the EOT to the sellers will not be classified as a distribution and therefore be liable to income tax.

The new regime will formally confirm this and therefore remove the requirement for an HMRC clearance to be obtained (which will take up to a month off the usual timeframe for a transition). 

Wrigleys comments

We are pleased to see that some of the generally accepted, and best market, practices are being codified into the law surrounding employee ownership and these should assist in the Governments policy objective for the EO sector of incentivising and supporting employee ownership and giving employees a greater stake in their businesses whilst narrowing the opportunity for the beneficial tax regime associated with EO from being misused (often to the detriment of the employees). 

We note that the updates do not go as far as requiring an EOT to have an independent trustee on the EOT board, which remains a highly recommended option in the sector and one which we will continue to advise is adopted.

We look forward to continue our support of the EO sector as an EOA Specialist Advisor and helping many more companies transition successfully to this excellent form of business ownership.