A growing form of private company ownership is the employee ownership trust. For many business owners looking for a succession solution, it has a number of attractions: it enables those who have contributed to its success to take over the ownership; it creates a strong platform for continued growth and success; and statutory tax reliefs allow owners to sell free of capital gains tax and employees to receive income tax free bonuses.
1. What is an employee ownership trust (EOT)?
An employee ownership trust is a particular form of trust for the benefit of employees. Unlike a conventional employee benefit trust, any benefit it confers on employees must include all of them (although a qualifying period of up to 12 months is allowed) on the same terms.
2. What is the purpose of an employee ownership trust?
Created by the Finance Act 2014, the clear goal behind the legislation is to encourage more companies to become employee owned.
3. Why is the government so keen to foster employee ownership?
There is strong evidence to show that employee owned companies outperform other companies in a number of ways, for example growth and resilience. Employee ownership is also seen to be one way to increase productivity of UK companies and there is research to back this up. Employee ownership also ensures that the profits of a successful employee owned company are more widely shared with those whose work has helped create them.
4. What are the tax incentives?
There are two main ones.
Company owners who sell a majority stake in their business to an employee ownership trust can claim a full exemption from capital gains tax.
Employees of a company that is majority owned by an employee ownership trust can be paid annual bonuses free of income tax, so long as these are paid to all qualifying employees on the same terms. There is an annual maximum of £3,600 per employee.
5. What does “same terms” mean?
The key point is that bonuses which are skewed towards higher paid or more senior employees cannot be paid income tax free. Either each employee must receive the same amount or (more commonly) different amounts according to a scale based on their salary, length of service or hours worked.
This doesn’t prevent a company paying larger bonuses to its key employees, but these will not be income tax free.
6. How does the trust pay for its shares?
Commonly, a price will be agreed (based on an independent assessment of market value) and payment will then be made in instalments, the trust being funded by the company from its future profits. Sometimes it is possible to arrange an external loan which will enable the purchase price (or a larger part of it) to be paid in one go.
7. Does this mean the employees manage the company?
No, the company will continue to have a senior management team whose role will be to run the company. Whilst they should be more inclined to listen to their employees views once the company has become employee owned, the employees will not be managing the company.
The trustees’ role will include ensuring that the company is being managed in a way which maximises employee engagement, but their role will not include management either.
8. What are the main advantages?
For a private company owner wishing to retire but looking for an alternative to a trade sale, an employee ownership trust is worth considering. It places the business in the hands of people who understand what makes it tick, have a strong personal commitment to its long term success and are highly motivated by their ownership to make it thrive.
Whilst the tax reliefs may be attractive, they should not be the sole reason for selling to an employee ownership trust. You will need to feel confident that employee ownership represents the best future for your company and that it fits well with your business’s culture.
9. Are there any disadvantages?
It is usual to be paid over a period of years, so if as a business owner you have the alternative of being paid full price by a trade buyer as a single payment, it may look less attractive financially to sell to an employee ownership trust.
10. Is there a successful employee owned company in my sector?
John Lewis is perhaps our most well known company owned by an employee ownership trust, but recent growth in the number of employee owned companies means that a wide range of sectors are covered, from manufacturing to construction, marketing to printing.
To find out more about employee ownership trusts, you can:
Look at the Employee Ownership Association website
View the video guides below
(Author: Robert Postlethwaite)