Employee Ownership Trusts: what are the proposed changes?

In July 2023 HMRC published an open consultation on the taxation of Employee Ownership Trusts (EOT) (and also Employee Benefit Trusts) as part of the Government’s “overarching support for employee ownership, giving employees a greater stake in the business in which they work and in turn driving productivity and growth”.

The EOT model has become the predominant model for employee ownership in the UK. The Employee Ownership Association estimates that over 1,000 companies have now transitioned to employee ownership, and the rate of uptake continues to increase, which is good news for employees as well as business owners who have benefited from tax-free sale proceeds.

However, the Government is considering changes to the EOT qualifying conditions. The key proposals in relation to EOTs include the following:

Control of EOT

The Government proposes that former owners (alone or when taken with persons connected to them) should be prevented from retaining control of the EOT. This would be achieved by requiring that more than half of the trustees of the EOT be persons who are not the former owners or persons connected to them. Any breach of these conditions after disposal would be a disqualifying event and lead to an immediate Capital Gains Tax (CGT) charge to the trustees (or to the former owner, if within the first year following disposal). This would encourage more use of independent professional trustee arrangements so may be welcomed by trust service providers if not the former owners themselves.

The Government is also interested in hearing views on whether conditions on EOT trustee appointments should require that one or more trustees be appointed or elected from employees of the company. Additional conditions such as these would help ensure that employee interests are represented adequately on the board but would reduce the flexibility the EOT model gives for tailoring the composition of the board to meet the circumstances of the company.

EOT tax residency

At present, there are no conditions regarding the residency status of EOT trustees. It is possible therefore to establish a non-resident EOT by appointing non-UK resident trustees, even if the former owner, company and employees are all located in the UK.

The trustees of a non-UK resident EOT would not be liable to pay CGT on any subsequent disposal of the target company shares, nor on a deemed disposal were a disqualifying event to occur. This means that it is possible to establish a non-resident EOT by appointing solely non-UK trustees, as part of an arrangement to reduce tax. The Government’s concern is that this could be part of a predetermined arrangement to dispose of the company to a third party without suffering the CGT that would otherwise be due.

The Government therefore proposes to introduce a requirement that the trustees of an EOT be a UK resident. This would require that either the trustees of the EOT all be UK resident; or that the trustees be a mix of UK resident and non-UK resident and that the former owner was UK resident or domiciled at the date the shares were disposed of to the EOT. A breach of this condition at any time after the disposal such that a UK-resident EOT becomes non-UK resident would result in a CGT ‘exit charge’.

If this change is implemented, it will no longer be possible to establish a qualifying EOT that is non-UK resident for tax purposes, whilst still allowing scope within the EOT rules to appoint non-UK resident trustees (alongside UK resident trustees) if this would be beneficial to the company. Offshore EOTs may have to consider redomiciling in the UK for tax purposes.

Tax treatment for EOT funding

To reduce uncertainty, the Government proposes to confirm in legislation that contributions made by the company to the EOT trustees to pay the former owners for their company shares, will not be treated as distributions for tax purposes. This would include associated stamp duty and any interest payable at a reasonable commercial rate. This would only apply if the consideration paid by the trustees for the shares does not exceed the open market value for those shares.

Tax-free bonuses

The Government is considering amending the qualifying bonus payment rules so that tax-free bonuses can be awarded to employees without directors necessarily also having to be included. These changes would make the tax-free bonus, a key incentive for the setting up of EOTs, easier to administer, and in turn make EOTs more attractive as a whole. Any changes would need to continue to ensure that the bonus payments cannot be weighted in favour of directors and the highest paid, or otherwise be exploited.

The consultation closes on 25 September 2023.

If you have any questions about these proposals or how EOTs can benefit you, please contact Andrew Bretherton.