Employee Ownership Trusts

Introduction

Employee Ownership Trusts (EOTs) are intended to support employee ownership of companies. EOTs provide indirect ownership of companies as employees are beneficiaries of an employee trust which owns shares in their employer. Various tax reliefs are available that are intended to encourage the use of EOTs.

This note provides a high-level overview of EOTs.

What are EOTs? 

EOTs 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.

EOTs should be viewed as a long-term vehicle. Due consideration should be given as to whether an EOT 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 EOTs where the requisite conditions are met:

• Capital Gains Tax (CGT) relief on disposals to EOTs: Individuals, trustees and personal representatives who transfer eligible ordinary shares to an EOT may be able to claim CGT relief. Where CGT relief is claimed on transfers made on or after 26 November 2025, 50% of any gain that would otherwise arise on the transfer to the EOT is deemed not to arise on this disposal.

The remaining 50% of the gain realised on transfer to the EOT is chargeable to CGT. Neither business asset disposal relief nor investors’ relief can be claimed on the 50% of the gain that remains chargeable. Higher and additional rate taxpayers are subject to 24% CGT on taxable gains, and so an effective 12% CGT rate would arise on the transfer.

• Inheritance tax exemption: No inheritance tax arises on eligible gifts or sales at undervalue to EOTs. Furthermore, trustees of EOTs are exempt from inheritance tax charges that may otherwise be chargeable, such as the up to 6% inheritance tax charge that can arise on each ten-year anniversary of the 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 EOT 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. Officeholders can benefit from the trust, though the trust will still be eligible to qualify as an EOT 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. This is to prevent the owners of a company selling to an EOT but failing to cease meaningfully acting as its owners.
• Trustee UK residence requirement: The trustees must be UK resident. This change was made with effect from 30 October 2024; EOTs set up before this date may be either UK or non-UK resident. The introduction of a UK residence requirement means that any gains made by the trustees on a disposal of shares in the trading company will be subject to CGT.
• 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 officeholders 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 to EOTs 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 four year period set out in the previous paragraph, the trustees are deemed to dispose of the shares they own and reacquire them for market value when the conditions cease to be met. The trustees may incur a CGT liability if a gain is made.

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 EOT.
• 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. There are exceptions for new joiners and leavers who were summarily dismissed or had committed gross misconduct. Directors can be excluded, though this is not required.
• 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 EOT include:

• Funding the EOT: In practice shareholders may sell their shares to the EOT with the proceeds left outstanding to be paid by the EOT as and when it receives distributions from the trading. An income tax exemption applies to dividends which the trustees use to fund their share acquisition costs. No income tax exemption applies to dividends received for other purposes, including relating to the EOT’s ongoing costs. Consideration should be given how the trustees will fund both initial and ongoing costs.
• Keeping tax relief: The EOT must meet various conditions for the four tax years following the tax year of transfer of shares to the EOT, otherwise the CGT relief claimed by the individual who made the disposal is withdrawn. It is the EOT that must meet conditions, and so CGT relief could be lost due to actions taken outside the control of the individual who will incur the tax liability.
• Valuation: The trustees 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 EOT 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 aid effective governance.
• Succession: Thought should be given as to how the current and future management team will be incentivised. This could include such individuals either owning shares or receiving share options. Companies controlled by EOTs are able to issue share options using the Enterprise Management Incentive (EMI) scheme.