For business owners thinking about succession, finding the right exit strategy can be a challenge.
Selling to a competitor might mean job losses, while a management buyout (MBO) is not always financially feasible.
However, another option available is the use of Employee Ownership Trusts (EOTs).
EOTs allow you to sell your business to your employees, ensuring continuity while benefiting from tax advantages.
However, with the Government proposing amendments to the rules on EOTs, particularly regarding tax treatment on distributions, it is important to understand how they work and whether they are the right fit for your business.
What is an Employee Ownership Trust?
An EOT is a structure that enables employees to take collective ownership of a company through a trust.
Instead of individual employees buying shares, a trust is established to hold a controlling stake in the business for the long-term benefit of all employees.
How does an Employee Ownership Trust work?
The business is first valued to determine a fair market price. A new EOT is then set up to hold shares on behalf of employees.
The trust purchases a controlling interest (at least 51 per cent) from the business owner, typically using company profits, bank loans, or vendor financing.
Employees benefit through tax-free bonuses and the long-term success of the business.
What changes are the Government making to Employee Ownership Trust rules?
Recent amendments to the Finance Bill 2024-25 are set to clarify the tax treatment of distributions made by a company to an EOT to fund the purchase of shares.
Historically, there has been uncertainty about whether these distributions were taxable, and many trustees sought HM Revenue & Customs (HMRC) clearance to confirm that no tax would arise.
The Government is now legislating to provide greater certainty on this issue.
Under the proposed changes, distributions made to an EOT will be reduced for tax purposes by the trustees’ “acquisition costs.” The new definition of acquisition costs includes:
- The cost of acquiring shares in the company
- Interest payments on acquisition-related loans (provided the rate is reasonable)
- Stamp Duty or Stamp Duty Reserve Tax on the acquisition
- Repayment of loans taken to fund the acquisition
- Valuation costs incurred in connection with the acquisition
- Other reasonable expenses directly related to the acquisition (excluding those related to ongoing ownership)
The Finance Bill 2024-25 is currently at the Committee stage in the House of Commons, so further refinements may be made before it becomes law.
Why consider an Employee Ownership Trust?
One of the biggest draws of an EOT is that it offers a 100 per cent Capital Gains Tax (CGT) exemption for the seller.
If you sell your business to an EOT, you pay no CGT on the proceeds, compared to the usual Business Asset Disposal Relief (BADR) or normal CGT rates.
Companies controlled by an EOT can pay employees annual bonuses of up to £3,600 tax-free, creating a strong incentive for performance and retention.
Unlike selling to a competitor or external buyer, an EOT protects the business’s identity and values by ensuring it remains in the hands of employees who care about its future.
EOTs remove the uncertainty of finding an external buyer and allow a business owner to step back gradually while ensuring a stable transition.
Potential downsides of an Employee Ownership Trust
Unlike a trade sale, where the owner is usually paid upfront, EOT sales are often financed over time using company profits.
This means the seller might have to wait years to receive the full value of their shares.
A successful EOT needs a business with strong profits and cash flow, as the company itself will often fund the buyout. Businesses with unstable finances may struggle to make the necessary payments.
Employees don’t automatically get direct ownership or decision-making power in an EOT.
Instead, the trust operates on their behalf, so you must clearly communicate how the structure works to avoid misunderstandings.
If you are considering an EOT, our team of experienced accountants and tax advisers can guide you through the process and help you explore the best options for your business, as well as updating you on any amendments that are passed in the Finance Bill 2024-25.
Contact us today to discuss your succession planning strategy.
