Setting up an Employee Ownership Trust as an Exit Route

An Employee Ownership Trust (EOT) is an entity controlled by trustees that buys the shares from the owner and its only aim is to provide benefits to the employees of the company.

Our client is a company owner who was looking to retire and who did not have any family members who wished to take over the business.

They decided to consider an employee ownership trust (EOT) to reward their employees for their hard work and loyalty over the years.

What is an Employee Ownership Trust (EOT)?

An EOT is an entity controlled by trustees that buys the shares from the owner and its only aim is to provide benefits to the employees of the company.

Why consider as EOT as an exit route?

Advantages of using an EOT

• No need to identify a third-party purchaser. Our client wanted to retire and trying to find someone to buy their private company may have been time consuming. Agreeing a price would have required negotiation and the process of selling may have been stressful.
• Where necessary conditions are met our client can benefit from capital gains tax (CGT) relief such that they had nothing to pay on this sale.
• Currently EOTs can make bonus payments to employees of £3,600 each year tax-free, which can encourage, retain and reward them for staying with the company.
• Should they wish owners can retain a small portion of the shares for future income and sentimental reasons.

Conditions of an EOT

HMRC requires the EOT and company to meet several conditions to receive this advantageous treatment.

Practicalities and next steps

If our client decided to go ahead with the EOT, we would recommend making a clearance application to HMRC and then liaising with a solicitor to draft a trust deed for the EOT.

Our client should consider who would make good trustees of the EOT. Often there is at least one employee and there may be a professional trustee too.

A formal valuation of the company is recommended. The company shares are then sold to the EOT. Since the EOT is newly set up and has no money, the owner is owed the sales proceeds as a loan. The EOT will repay the loan (the sales price) over time as it receives dividends from the company.

Employee Ownership Trust Problems/Risks

There are risks to be aware of when using EOTs as an exit route. These include:

The loan  if the profitability of the company falls and it does not fund dividends to the EOT, there may not be money to repay the owner.

Inheritance tax (IHT) the owner has exchanged a trading business for a loan/cash. This could mean a loss of business property relief in their eventual estate, so increased IHT, depending on the circumstances.

HMRC counteraction challenge by HMRC is always a risk if they consider the main purpose to be tax avoidance.

Law change as with any tax legislation, these rules are subject to future changes. The treatment now may not always be the future treatment.

EOTs have been the subject of a consultation by HMRC which ended in September 2023. At the time of writing the outcome of that consultation has not been published.

If you would like to discuss how an EOT may be of interest to you please contact me, Sarah Messruther.

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