Employee Ownership Trust

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Tax incentives for companies majority owned by an employee ownership trust.

The Finance Act 2014 introduced two tax reliefs designed to encourage and support the creation and growth of employee-owned companies.

Watch our animated guide to Employee Ownership Trusts

1. Full relief against capital gains tax

No CGT if you sell more than 50% of company to an EOTThe sale of a controlling interest in a business to an employee ownership trust (EOT) will be entirely free from capital gains tax (CGT).

What is an employee ownershop trust?

An EOT must meet the following requirements:

  • The company whose shares are transferred must be a trading company or, where there is a group, the principal company of a trading group.  A company which has significant cash, land or other investments may not be a trading company.
  • The EOT must meet the “all-employee benefit requirement” – see below.
  • The EOT must not hold a controlling interest of more than 5% in the company before the transfer to it. However, the EOT must hold a controlling interest in the company at the end of the tax year in which the transfer to it takes place.
  • Where the transferor has an interest of more than 5% in the company in the 12 months before he transfers his shares to the EOT there is an additional requirement. The requirement is that the number of employees who hold 5% or more of the company must not exceed two fifths (2/5) of the workforce generally. (please see the worked example below.)

Example of the 2/5 ratio in operation : CGT relief

A company has 3 people who each hold more than 5% of the Company’s shares and are employees or directors (Shareholder Employees). and a total of 9 people who are employees.  On the face of it, the ratio will be 3/9 which would satisfy this ratio requirement. If, however, one of the 9 is, for example, the son of one of the Shareholder Employees, he will be counted in with the Shareholder Employees as a relative. The ratio will become 4/9 which will not satisfy the requirement and it will not be possible for any selling shareholder to claim the CGT exemption.

This is a complicated aspect and specific advice may be required in individual circumstances.

 

What is the “all-employee benefit requirement”?

Broadly, if the EOT provides benefits (such as cash or shares) to individual employees, it must generally do so in favour of all eligible employees, and must do so on the same terms (separately called the “equality requirement”). The EOT cannot, therefore, skew benefits to the advantage of particular employees, although it can allocate benefits of differing amounts by reference to factors such as salary, length of service or hours worked. “Employees” can also include certain dependants of deceased employees.

2. Income tax free bonuses

Income tax free bonuses if EOT holds more than 50% of the companyBonuses paid to employees of companies controlled by an EOT benefit from an income tax (but not national insurance) exemption.

What are the conditions for the income tax relief?

The key requirements for income tax relief are:

  • The employer company must be a trading company or a member of a trading group.
  • A controlling interest in the company or, in a group of companies, the principal company in the group, must be held by an EOT, for at least twelve months.
  • Provisions very similar to the equality requirement for the CGT exemption also apply to the income tax exemption. The trust must have existed as an “all-employee trust” for at least twelve months. The trust must have existed as an “all-employee trust” for at least twelve months.
  • The company should not have more than a ratio of 2/5 for  directors (plus any employees related to them) to employees and directors in total. (Please see the worked example below.)
  • There is a maximum limit of £3,600 income tax free bonus per employee per tax year
  • The payment must not consist of normal salary, must not be made by a service company and must be made under an arrangement under which:
    • all employees of the company, or, where there is a group, any group company must be eligible to participate in any award (although employees with continuous service of less than 12 months can be excluded); and
    • all employees participating in the arrangement must do so on equal terms (although awards can be determined by reference to pay, length of service or hours worked).

Example of the 2/5 ratio in operation: income tax free bonuses

A company has 3 people and 9 people who are either employees or directors.  On the face of it, the ratio will be 3/9 which would satisfy this ratio requirement. If, however, one of the 9 is, for example, the son of one of the directors, he will be counted in with the directors as a relative. The ratio will become 4/9 which will not satisfy the requirement and it will not be possible to pay income tax free bonuses.

This is a complicated aspect and specific advice may be required in individual circumstances.

 

If you would like to explore how employee ownership might be introduced in your company, please contact us for an initial discussion.

We are happy to meet at our offices without charge or commitment and will be very pleased to hear from you.

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