Employee Ownership Trusts

Introduction

Employee ownership trusts were introduced in 2014 with a view to supporting employee ownership of companies and are now increasingly being implemented. Various tax reliefs are available that are intended to encourage the use of employee ownership trusts, thereby providing employees with indirect ownership of their employers. 

This note sets out a high-level overview of employee ownership trusts.

What are employee ownership trusts? 

Employee ownership trusts are a form of trust that own shares in a trading company or the principal company of a trading group and which operate for the benefit of that company or group’s employees. On the basis the trust is discretionary, the trustees can decide if and when employees should be able to receive payments or other benefits from the trust.

Employee ownership trusts should be viewed as a long-term vehicle. Due consideration should be given as to whether an employee ownership trust is an appropriate ownership structure for the company, taking into account the company’s culture and incentivisation of both current and future employees, including the management team.

Tax reliefs 

The reliefs below are available in connection with employee ownership trusts where certain conditions are met:

• Capital Gains Tax (CGT) relief on disposals to employee ownership trusts: Individuals, trustees and personal representatives who transfer eligible ordinary shares to an employee ownership trust may be able to claim CGT relief on the transfer. Where CGT relief is claimed, the transfer to the trust is deemed to give rise to neither a capital gain nor a loss.
• Inheritance tax exemption: No inheritance tax arises on eligible gifts or sales at undervalue to employee ownership trusts. In addition, trustees of employee ownership trusts are exempt from inheritance tax charges that may otherwise be payable, such as the up to 6% inheritance tax charge that can arise on each ten-year anniversary of a trust being created.
• Income tax exemption on bonus payments to employees: Bonus payments of up to £3,600 per annum are exempt from income tax for the recipient employees. No national insurance contribution exemptions apply and so both the employees and their employer will need to pay national insurance contributions on bonus payments made.
• Corporation tax deduction: The employing company is eligible for a corporation tax deduction when bonuses eligible for an income tax exemption are paid to employees.

Further detail on the CGT relief and income tax exemption is set out below.

Key conditions that must be met for CGT relief to be available

The key conditions that must be met for CGT relief to be available on the transfer of shares into an employee ownership trust on or after 30 October 2024 are summarised below:

• The trading requirement: The company must be a trading company or the principal company of a trading group. A ‘principal company’ is essentially a holding company that owns at least 75% of shares in its subsidiary companies and meets certain other requirements.
• The controlling interest requirement: The trustees must have a controlling interest in the trading company (or principal company) at the end of the tax year of the transfer(s) on which CGT relief is to be claimed, which they did not have at the beginning of the tax year. CGT relief is not available on transfers to the trust in other tax years.
• All employee requirement: Broadly, all employees must be able to benefit from the trust, though there are exceptions to this rule. For example, new joiners with less than 12 months service can be excluded from benefit. Office-holders can benefit from the trust, though the trust will still be eligible to qualify as an employee ownership trust if they are excluded.

When deciding the benefits to confer on employees the trustees can consider each employee’s remuneration, length of service and/or hours worked, provided all eligible employees receive at least some benefit.

• Excluded participators: Certain persons must be excluded from benefiting from the trust. These are certain persons who, either from the date of transfer or at any point in the preceding ten years, beneficially own or are entitled to acquire at least 5% of shares or any class of shares in the company, and who would be entitled to receive 5% or more of the company’s assets on a winding-up. People connected with such participators must also be excluded. Connected people for this purpose is widely defined but includes spouses, civil partners and children.
• Trustee independence requirements: At least 50% of the trustees must not be excluded participators (as above) and excluded participators must not control the settlement. In particular, excluded participators must not have the power to apply trust property or make certain changes to the terms of the trust. This is to prevent the owners of a company selling to an employee ownership trust but failing to cease meaningfully acting as its owners.
• Limited participation requirement: Broadly, either (i) the person making the transfer must not be a participator in the company during the twelve months ending immediately after the transfer to the EOT and/or (ii) immediately following the transfer and for the remainder of the tax year of the transfer, fewer than 40% of the total number of employees and office-holders in the company are participators. Participator is defined as set out in the preceding bullet point.
• Consideration requirement: The trustees must take all reasonable steps to ensure the price they pay for the company does not exceed market value.

There are set time periods over which the above conditions must be met for CGT relief to be available. Notably, for transfers made to employee ownership trusts on or after 30 October 2024, any CGT relief claimed will be lost if the above conditions cease to be met between the point of transfer and the end of the fourth tax year following the year in which the transfer takes place. Where this occurs, the person who made the transfer is deemed to have sold their shares to the trustees for market value and CGT may arise as a result of this.

If the aforementioned conditions cease being met at some point after the end of the fourth tax year following the transfer, the trustees are deemed to dispose of the shares they own and reacquire them for market value when the conditions cease to be met. This will result in a CGT liability for the trustees on any gains. Although some companies have in the past been sold to trustees located offshore and therefore outside the scope of CGT, for disposals from 30 October 2024, the trustees of an employee ownership trust as a body must be UK resident.

Income tax

• Qualifying bonus payments of up to £3,600 per employee per annum are exempt from income tax, though both employee and employer national insurance contributions must still be paid, as must the apprenticeship levy where applicable.
• Bonuses must be paid by the employing company – not by the employee ownership trust.
• The income tax exemption is only available provided all eligible employees receive a bonus from their employer, including ‘excluded participators’ who must be excluded from benefiting from the trust for CGT relief to be available. Employees can be excluded from receiving bonuses if they are new joiners with less than 12 months’ service or in certain circumstances where an employee has committed gross misconduct or is summarily dismissed before the bonus is paid. It is also possible (but not required) to exclude directors.
• Either all employees must receive the same amount of bonus or, where the bonus amount varies, it must only do so based on (i) remuneration; (ii) length of service and/or (iii) hours worked. Exemption is denied if the effect of the variation is to confer relief wholly or mainly on directors, the highest earners or people employed in specific parts of the business or undertaking certain kinds of activities.

Practical considerations 

Additional points to consider when deciding whether to pursue an employee ownership trust include:

• Funding the employee ownership trust: No exemptions apply to facilitate loan funding of the employee ownership trust in order to purchase the vendor’s shares. In practice, this may result in sale proceeds being left outstanding and gradually repaid using company profits (and there is now a specific relief which confirms contributions out of company profits for this purpose will not be taxed as a dividend in the hands of the trustees). Any impact on the total amount receivable and cash flow implications should be considered.
• Valuation: The trustee will normally need to obtain independent professional valuation advice in order to satisfy itself that it is not overpaying for shares in the company.
• Tax clearances: It is prudent to apply to HMRC for tax clearances, including on whether HMRC consider that a proposed trust would qualify as an employee ownership trust and on the tax position of the vendor’s consideration.
• Governance: Consideration should be given to how the trust and company will be run, taking into account the interaction between the company’s directors and the trustees.
• Employee communication: Employee ownership can act as a powerful employee incentive, though effective communication is essential. This may include establishing an employee council. This could also aide effective governance.
• Succession: Thought should be given as to how the current and future management team will be incentivised. This could include such individuals directly owning shares in the company. Alternatively, employees could be granted share options, such as through the Enterprise Management Incentive (EMI) scheme, the rules of which are modified to enable share options to be issued by companies controlled by employee ownership trusts.