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Tax reliefs for transitioning to an employee-ownership model, via an Employee Ownership Trust (EOT), have now been in place for seven years and the Chartered Institute of Taxation (CIOT) have flagged some areas where there may have been scope for abuse of the relief and where EOT governance structures are ripe for improvement. In September 2021, the CIOT put forward proposals for HMRC and the Treasury suggesting a consultation on reforms to the EOTs rules. It is possible that the Government will follow-up on the idea of reforms and launch a call for evidence or formal consultation on reforms.
Growing use of EOTs
Selling a business to an EOT continues to be a very popular exit route for business owners. Statistics from the Employee Ownership Association show that 148 new EOTs set were up in 2020 (a record year) with a further 113 EOTs established in the first half of 2021. Indeed, we are seeing a continuing stream of enquiries from business owners keen to make the transition to employee ownership.
Benefits of employee-ownership
Research has shown that employee-owned businesses are typically more profitable, have more engaged/productive workforces, have lower levels of staff turnover, higher levels of productivity and are generally seen as better places to work – an important bonus when staff recruitment is so difficult. However, it is possible that the increased popularity of EOTs may also stem from the capital gains tax relief available to business owners on a sale to and EOT – this is much more attractive since the end of Entrepreneur’s Relief and its replacement with the less generous Business Asset Disposal Relief (BADR). Read more on how transition to an EOT works here.
The way in which the CGT relief is provided to departing shareholders is that the trustee of the EOT acquires the shares on a “no gain, no loss” basis, so that the trustee of the EOT inherits the selling shareholders’ base cost. As a result, when the trustee of the EOT eventually sells the shares at some point in the future, the aggregate gain will become subject to CGT in the hands of the trustee at the prevailing rate. However, if the trustee is located offshore, the held over capital gain may never become subject to UK capital gains tax.
Residency of the EOT trustee
The CIOT has urged the Treasury to consider whether this constitutes a loophole: the CIOT has identified that some advisers appear to be endorsing EOTs solely as a tax planning exercise to structure business sales entirely free of CGT.
Where offshore trustees are used, tax reliefs for the departing shareholders can be secured and then after a couple of years the business is sold onward to a third-party buyer avoiding any capital gain crystallising in the trust and thus avoiding UK tax.
We understand that the reason the Government did not make it mandatory for the trustee of an EOT to be UK tax-resident is because it would have breached EU competition laws. However, now that we have exited Europe, it is now open to the Government to only permit tax free sales to EOTs with UK trustees.
In our experience, most owners remain keen to retain the EOT trust company on-shore and for one, or more, of the departing shareholders to sit on the board of trustees in order to provide oversight of the EOT until the deferred consideration owing to departing shareholder has been paid. However, we would whole heartedly endorse a move to tighten the rules in this area.
Composition of the trustee board
The composition of the trustee board is another area where the CIOT have made recommendations to curb potential mismatches between practice and the overriding premise of employee ownership and engagement. Best practice is generally that a combination of departing shareholders, employee representatives and a non-executive director as chairman is the most appropriate make-up of the trustee company board: this provides appropriate checks and balances and the best protection of the interests of the beneficiaries of the EOT (the company’s employees).
The current EOT legislation does not comment on who can be directors of a corporate trustee of an EOT. Whilst very prescriptive rules on trustees would not be helpful, the idea that the departing shareholders could no longer make up most of the board of directors of the EOT trustee company would ensure that all companies have a balance of interests on the board following sale of the EOT.
The CIOT has also called for welcome reforms to ease the costs and red tape associated with establishing EOTs (including HMRC clearances) and to provide more guidance and make it easier for taxpayers to claim the EOT relief on their tax return.
If the government adopts the idea of reforming EOTs BDO will, of course, take part in the consultation process. In the meantime, if you would like further information on employee ownership trusts and how BDO can help convert your business to an employee ownership structure, please contact Matthew Emms or Andrea Bunbury.
Succession Planning: Selling your business to an EOT