New tax reliefs for employee-owned companies

10th April 2014

Finance Bill 2014 confirms two new tax reliefs designed to encourage and support the creation and growth of employee-owned companies.

Employee ownership can take the form of direct ownership (where employees hold shares in their employing company), indirect ownership (where shares are held collectively on behalf of employees, often through an employee benefit trust (EBT)), or some combination of the two.

Existing tax-advantaged share plans encourage employees to make direct acquisitions of shares in their employer company on an individual basis, rather than encouraging the holding of shares indirectly on behalf of employees.

Under the first new tax relief, the sale of a controlling interest in a business to an indirect employee ownership structure (to be known as an “employee ownership trust”) will be entirely free from capital gains tax (CGT).  

An employee ownership trust (EOT) must meet certain 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.
  • The EOT must meet the “all-employee benefit requirement”.
  • The EOT must not hold a controlling interest in the company before the disposal, but must do so at the end of the tax year in which the disposal takes place.
  • Where the transferor has an interest of more than 5% in the company in the 12 months before the disposal, the ratio of employees who are participators to employees generally must not exceed 2/5.

The all-employee benefit requirement means, in the main, that if the EOT provides benefits (such as cash or shares) to individual employees, it must generally do so in favour of all eligible employees on the same terms (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.

In the course of consultation, the Government accepted that it could be difficult for existing EBTs to satisfy the all-employee benefit requirement without significant changes to their constitutional documents. It has, therefore, introduced deeming provisions to the Finance Bill whereby an existing EBT can be deemed to meet the all-employee benefit requirement, if, broadly, the way in which it operates is consistent with the all-employee benefit requirement, it had at least a 10% shareholding in the underlying company at 10 December 2013 and subsequently obtains control of it.

The new relief is available for disposals on or after 6 April 2014.

Comment: Ownership succession by selling to an employee trust has grown in popularity in recent years, but is not yet widely understood and has so far been chosen by only a small proportion of companies. However, it is generally no more complex than a trade sale and is often simpler. It is particularly well-suited to companies whose value largely derives from the talents of its employees. This new relief is intended to encourage more business owners to go down this route. The important practical point is that a seller or sellers wishing to benefit from full CGT relief will need to ensure that the EOT receives a 100% holding in a single tax year.

Under the second tax relief, bonuses up to £3600 per tax year paid to employees of companies controlled by an EOT benefit from an income tax (but not National Insurance) exemption.

The key requirements for the new 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 situation, the principal company of the group, must be held by an EOT.
  • Provisions very similar to the equality requirement for the CGT exemption also apply to the income tax exemption.
  • The company should not have a ratio of more than 2/5 for office holders and directors to employees.
  • 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).

The new relief will apply to payments on or after 1 October 2014.

Comment:  Any company which is or becomes majority owned by an EOT should investigate this new relief further. It doesn’t prevent bonuses also being paid on a discretionary basis to selected employees, although these will not benefit from the tax exemption.