Chancellor Rachel Reeves delivered her first budget speech on 30 October 2024. Whilst not directly dealt with in the Budget, changes to rules around the structure of employee ownership trusts (EOT) and employee benefit trusts (EBT) were also announced on 30 October 2024. These were in response to a consultation process which was started in 2023 and was recently published. The changes in full are effective from October 30th 2024, the date of the budget speech, and are also included in the forthcoming Finance Bill 2025.
Given the increased popularity of EOTs as a vehicle to exit a business, the consultation concluded that increased regulation of EOTs was desirable to avoid abuse of the legislation.
It is likely that EOTs will becoming increasingly popular given the increased in Capital Gains Tax from April 2025. Subject to compliance with the rules, any transition of the ownership of a business to an EOT remains tax-free even after April 2025.
A summary of the changes:
- Former business owners and their connected partners cannot retain control of the business after it has been sold to the EOT. In practice this means that former owners will not be able to have a majority on the board of trustees.
- The trustees of an EOT must be UK residents at the time of the sale to an EOT.
- The trustees of the EOT must take reasonable steps to ensure that the consideration paid to acquire the shares does not exceed market value.
- Contributions made by a company to an EOT to pay for the shares will not be subject to income tax.
- Tax-free bonuses can be awarded to employees without directors being included in the bonus pool. It was previously mandatory for directors to be included.
- The scrutiny period for tax relief has been increased to the end of the fourth tax year.
- Disposals qualifying for inheritance tax when transferring a business to an EOT/EBT have been changed.
A positive result of the budget is that there has been no change in the tax treatment of EOTs. EOTs remain a very tax efficient way for a business owner to sell a business, as capital gains tax is not required to be paid by the owner selling the business, as long as they comply with the requirements of sections 236H to 236U of the Taxation of Chargeable Gains Act 1992. Capital gains tax will increase to 24% for higher income taxpayers following the budget (and 14% on those disposals which qualify for Business Asset Disposal Relief), and hence this exemption represents a significant financial benefit for sellers of an EOT.
What the changes mean
Restricting former owners or persons connected with former owners from retaining control of a company after selling it to an EOT, does not mean they cannot still be a trustee of the EOT or a director of the business. It just means they cannot have ultimate control of it hence why the sellers cannot have a majority on the board of trustees. This could be avoided by creating an EOT board, with a variety of trustees but whereby the sellers/founders can be represented on the board, but are not a majority and therefore have no controlling interest.
Changes relating to controlling the market value of shares have been introduced to ensure that sellers/founders don’t seek to sell at an inflated price. This could occur if the founders were also trustees, and such a move could therefore breach their duties as a trustee. So any sale must be accompanied by an explanation from the trustees, which sets out the reasonable steps taken to settle on the share prices agreed. This will ordinarily involve the trustees seeking an independent valuation of the business.
Removing the requirement to charge distributions to income tax when the company is paying for EOT shares is aimed at streamlining the sale process. This removes unnecessary bureaucracy from the process of the initial distribution and subsequent distributions to employees.
Finally, the changes made to inheritance tax qualifications include a new criteria:
- Shares must have been held for a minimum of two years before being transferred to the EOT/EBT.
- No more than 25% of the beneficiaries receiving income from the EOT/EBT sale can be connected to the seller. This prevents family members of the seller benefitting disproportionately from the sale, such as receiving duplicate tax reliefs. This ensures that tax advantages represent the true spirit of EOTs, ie. they benefit employees equally, rather than benefitting family members of the original owners.
It is now the case that many people considering becoming an EOT, or who have just been through the process, may need to review their organisational structure and set-up and possibly revise it, in order to align with these latest requirements. If you need effective, professional advice on EOTs, the process of becoming one and what these changes now mean, you can contact the Employee Ownership Advisor today.
