With a potential change in legislation on the horizon, could there be an opportunity to benefit from the current rules such that there is no capital gains tax (CGT) payable on the disposal of your business?
EOTs have grown in popularity, not least following the reduction in the limit on business asset disposal relief (formerly entrepreneurs relief) to £1m with effect from March 2020.
An EOT is a specific type of trust designed to hold shares of a company for the benefit of its employees. Whilst not a new concept, disposals to these types of trusts were granted special tax status in 2014.
Some of the reasons business owners lean towards a sale to an EOT are as follows:
- Tax efficiency – a sale to an EOT can be completely tax free for the vendor
- Business continuity – it facilitates ongoing trading and employment for the workforce
- “Friendlier” transaction – as all parties are known to each other
- Funding – typically there is no requirement for external funding as the vendor funds via deferred consideration
Is the structure complicated?
Not necessarily. A trust must be created which meets the requirements of the legislation. Typically, the trustees are a trust company such that board members can be appointed. These are likely to be a mixture of current employees of the target company, possibly a professional trustee and in some cases the vendor.
The shareholders and trustees will agree a fair valuation for the shares in the target company which are subsequently sold to the EOT.
In most cases an element of the consideration is left outstanding and paid to the vendor over time through the profits generated by the company.
Benefits of an EOT structure
The trust will hold the shares for the benefit of the company’s employees, giving them a direct interest in the ongoing success of the business. EOT owned companies can further incentivise their employees by offering income tax free bonuses of up to £3,600 per year to their employees through a bonus scheme.
An EOT provides a ready buyer for the disposal of your shares. Typically, this reduces the length of time it takes to complete a sale compared to a third-party sale.
Following the sale, the company continues to be run by the experienced management team who already have considerable knowledge and understanding of the business.
What are the key requirements?
There are a number of key conditions that must be met in order for the trust to be a qualifying EOT. Which include the following:
- The company must be a trading company or the holding company of a trading group (the “trading requirement”)
- The trust must acquire at least 51% of the shares in the company (the “controlling interest requirement”)
- The trust must be run for the benefit of all employees on the same terms (the “all-employee benefit requirement“)
- The number of shareholders (and their family) employed by the business must be fewer than 2/5ths of the total employees (the “limited participation requirement”)
These conditions need to be carefully considered in order to ensure the disposal qualifies for the beneficial tax treatment. This is both at the point of sale and in the future to prevent there from being a ‘disqualifying event’ which could create a tax charge arising on a deemed disposal of the shares for the trustees.
The appeal of selling a business to an EOT will depend on individual circumstances and needs to be balanced with the acceptance that the vendor’s consideration will be paid over a number of years and risks that are associated with this.
However, in the right circumstances, EOTs can provide a tax efficient exit and an effective way to incentivise the employees to maintain business performance going forward.
This is an area where there is great potential for reward if you have the right company, but such a complex area carries a need for professional advice. Lovewell Blake has a specialist team with experience in advising on sales to an EOT, share schemes, and similar transactions across a variety of industries.