Employee Ownership Trusts Information

This note will briefly describe what an Employee Ownership Trust (EOT) is, the advantages and disadvantages of establishing an EOT to control your business and how Hamilton Blake can assist with the process.


EOTs are one of the most common methods of introducing employee ownership, the other being employee share schemes.

Employee Ownership Trusts Information

What are they?

An Employee Ownership Trust is a tax incentivised mechanism that transfers control of the business for the long-term benefit of employees. It was introduced in its current form in 2014 when the Finance Act bought in new legislation to try and incentivise more employee ownership. The legislation was introduced to incentivise companies to sell out to employee-owned vehicles.


An EOT is a special statutory trust established by a trading company for the benefit of all its employees. EOTs are used to benefit all employees equally but distributions may consider remuneration level, length of service and hours worked.


An EOT does not mean employees directly own the shares; it means that the shares the trust holds will be ultimately used to the benefit of the employees at the point of a distribution an annual bonus distribution. That doesn’t necessarily mean it will be today’s employees; instead, it will be the employees in the business at the time of the bonus grant or on exit, i.e., it is employees as a body rather than individual share ownership.


Why do it?

EOTs are becoming increasingly more popular, the popularity of EOTs is driven both by the tax and employee benefits. Companies are introducing EOTs to provide permanent or long-term employee ownership of the company.


The advantages of establishing an employee ownership trust are as follows:


  • The tax advantages: Provided certain conditions are met, the sale of shares to the Employee Ownership Trust is free of any capital gains tax liability for the seller. Further eligible employees can be paid bonuses of up to £3,600 per year with zero income tax liability.
  • The trust is a ready-made purchaser: ordinarily selling shareholders typically need to find a buyer in order to sell their company. By creating the trust, the selling shareholders can sell their shares without going through the process of finding a buyer.
  • Succession planning: similarly, the trust removes the requirement for business owners to spend time searching for a suitable buyer whose values match those of the existing owners, the employees, and the company ethos. The trustees can include the existing owners, resulting in a seamless transition and minimal disruption to the day to day running of the business. There is no immediate need to change the operational process of the company. Allowing management and operational decisions to continue to be made in accordance with the existing governance and operational framework of the business.


Along with the tax benefits for departing shareholders and employees the structure enables owners to release value from their business and implement a succession plan over the long term without bringing in an external third-party buyer or investor.


Disadvantages

Below we have outlined a number of disadvantages of establishing an employee ownership trust:


  • Potential lack of immediate funds – with a normal sale a purchaser will often make an immediate cash payment and further payments based on the future results of the company, an earn-out. However, an employee ownership trust starts with no money and so, unless the company has sufficient surplus cash, its ability to make an immediate payment is likely to be limited to the amount it can borrow. The selling shareholders are therefore likely to receive the bulk of their proceeds on a deferred basis, payable out of future profits of the business, when these are available and are received by the trust.
  • Lack of control – although the selling shareholders can have a large degree of influence after the sale, ultimately the trust will have a controlling interest in the company. After the sale, the company is largely owned by an employee benefit trust, operating for the benefit of the employees.
  • Potential tax downsides –
  • Stamp Duty: there will be a stamp duty liability of 0.5% of the value of the company.
  • Potential liability: the tax relief on the sale of the shares will not apply to any ‘earn out’ element of the consideration. For instance, if the selling shareholders are to receive further payments the amount of which depends on the future performance of the company.
  • Loss of relief: Any tax relief on the initial sale of the shares will be lost if the trust sells its controlling interest or the company ceases to be trading.

Future

A subsequent trade sale, management buy-out (MBO) or initial public offering (IPO) of the business can take place in the future and, since the EOT must act in the best interests of the employees, the trustee would support a future exit if it realised sufficient value for the employees. An exit strategy can be agreed with the EOT at the time it becomes a shareholder, as with any other investor.


Key Qualifying Conditions

Due to their tax advantages, there are a number of conditions that need to be satisfied by both the company and the trust in order for the EOT to be tax efficient.


The Company

To carry out a qualifying sale to an EOT there are key conditions the company must meet:

  • the seller must be an individual or a trust, not another company,
  • the shares must be ordinary shares, not preference shares,
  • the company must be a trading company, or the principal company of a trading group, which broadly means that at least 80% of the activities must be trading activities,
  • the trust must acquire a controlling interest in the company (at least 51%); and
  • after the sale, at least 60% of the employees must not be significant shareholders.


The Trust

The trust which acquires the shares has to satisfy the following conditions:

  • the trust must generally be for the benefit of all employees of the company or group. The employees must benefit on the same terms, although employees who have worked for the company or group for less than a year can be excluded, and the trust can permit funds to be applied for charitable purposes,
  • the trust must exclude employees who in the last 10 years have previously owned 5% or more of the shares in the company (or of any class of shares in the company), or who on a winding-up would be entitled to 5% or more of the assets of the company, and anyone connected with such employees must likewise be excluded,
  • the trust can allow employees’ entitlements to vary with their remuneration, length of service or hours worked, but all eligible employees must have some entitlement; and
  • the trust cannot make loans to the employees.


How can Hamilton Blake help?

Hamilton Blake can help with structuring the introduction of an EOT, including liaising with the appropriate corporate lawyers in preparing the documentation, agreeing a share valuation for the shares to be sold, and taking you through the entire process of introducing an EOT as the majority shareholder of your company.


Completing the process of establishing an EOT with Hamilton Blake can be split into the following steps:


  1. Initial Call – We would seek to arrange an initial call with you to further explain what the introduction of an EOT means for both the company, its shareholders and its employees. This would also be an opportunity for us to answer any initial questions you have and also learn about you and your company so we can advise on which route will be most beneficial for you and your company.
  2. Initial Report – After the initial call we would produce a detailed note on the potential routes that would be available to your company, including an EOT as well as other potential routes such as an employee share scheme. This note would outline the different options and the tax implications for each: the company, the shareholders and the employees.
  3. Follow up call – We would then seek to arrange a follow up call to go through any further queries you have once we have collectively decided on the optimal route for your company we would then liaise with the appropriate corporate lawyers to discuss the legal aspects of any share restructure.
  4. Final report – Hamilton Blake would then produce a final report outlining the steps we intend to take and the tax implications of each stage. Should a purchase of shares be the preferred route this note would outline each of the legislative conditions and how they are satisfied.
  5. Drafting of clearance application – Upon a final review of the final report, we would then draft a clearance application to HMRC which would out outline each of the legislative conditions and how they are satisfied, such that you receive capital treatment on the disposal.
  6. Liaising with HMRC and corporate lawyers – HMRC will then either agree or disagree with our tax analysis or request further information. Once we receive clearance from HMRC, we will liaise with the appropriate corporate lawyers to draft all the necessary documentation.
  7. Implementation – Once all the legal documentation has been drafted we would then be in position to implement the introduction of an EOT and complete the trusts acquisition of the issued share capital in the company.


Should you have any queries about the process or whether a EOT may the right route for you and your company then please do not hesitate to contact us.