Introduction to Employee Ownership Trusts

Employee Ownership Trusts (EOTs) are a way of promoting employee ownership and increasing employee engagement. 

What is an Employee Ownership Trust?

The Government initiative was formed in 2014 to facilitate employee ownership. It’s becoming a popular exit or succession planning strategy, particularly for founders who don’t want to sell their business completely.

Companies can adopt an employee ownership structure by enacting an Employee Ownership Trust, which allows shareholders to sell their shares for the full market value to employees. However, employees don’t use their own money to buy the shares. They get an indirect stake in the business, increasing engagement and commitment that results in high-performing teams. The Government affords generous tax breaks to companies that open Employee Ownership Trusts, such as capital gains relief and inheritance tax exemption. However, the EOT must be structured in a particular way to qualify for the tax breaks.

Who manages the Employee Ownership Trust?

The EOT is managed by trustees. The trustees are usually comprised of an employee representative, directors or founders, and an independent representative(s), such as an accountant. Exiting shareholders can also sit on the board of trustees, although HMRC lays out specific rules and conditions on this. The trustees’ role is to ensure that the company is being managed in the best interest of the employees and that the EOT is successful in maximising employee engagement.

Employee Benefits of EOTs

• Employees become active stakeholders without having to use their own money to buy shares.
• Existing Shareholders can sell their shares for the full market value.
• There are usually no capital gains, income, or inheritance tax liabilities, saving existing shareholders 20% capital gains tax on the sale of their shares to the EOT.
• Employee-owned companies can pay tax-fee cash bonuses to employees – up to £3,600 per employee per year.
• Employees can get a greater, genuine say in how the business is run.

Company Benefits of EOTs

• Employee Ownership Trusts are considered a ‘friendly purchaser’, typically resulting in a quicker process with lower fees.
• Employees get a stake in the company, so they are more likely to be motivated, engaged, driven, and innovative.
• Employee-owned companies have found reduced absenteeism and higher retention.
• An Employee Ownership Trust allows for a smoother transitional process if the owner wants to exit the business, especially when there is no third-party purchaser. Additionally, it helps to preserve the business, rather than being sold to the highest bidder and disappearing completely.
• Shareholders can exit quickly and seamlessly.
• The owner can retain involvement in the business of up to 49%.

Tax relief of EOTs

As mentioned previously, the tax reliefs are a huge benefit to transitioning into an Employee Ownership Trust.  Here are the key tax reliefs of an Employee Ownership Trust:

Capital Gains Tax (CGT) relief: Those who transfer shares to an EOT can claim CGT relief.

Exempt from inheritance tax: EOT trustees are exempt from inheritance tax charges. The main inheritance tax implication is the 6% inheritance tax charge that can arise on a trust’s 10th anniversary, and EOT trustees are exempt from this.

Exempt from income tax on bonuses: Bonuses of up to £3,600 can be paid to employees and are exempt from income tax. These bonuses must be paid by the company, not by the EOT. The income tax exemption is only afforded if all eligible employees receive a bonus. If the bonus amount varies, then it must be based on length of service, hours worked, or remuneration.

Corporation tax deduction: The company is eligible for corporation tax deduction when the tax-free bonuses are paid to employees.

Employee Ownership Trusts are not exempt from National Insurance contributions and will have to pay this on bonuses.

Key qualifying conditions of an EOT

• The trust must have a controlling stake of at least 51% of the business.
• All employees must benefit from the trust. The EOT cannot afford benefits to particular employees and not others, although it can distinguish the amount based on length of service, hours worked, or remuneration. Additionally, new joiners with under 12 months of service can be excluded from the benefit.
• Certain participators are excluded from benefiting from the trust. Those who have a 5% or more interest in the company or are entitled to receive 5% of the company’s assets are excluded. That includes the participator’s children, spouses, and civil partners.

Examples of Employee Ownership Trusts

There are over 1,400 partially or fully employee-owned businesses in the UK. It’s proven to be a beneficial and motivating structure, and more companies follow suit every year. Here are 3 examples of successful employee-owned businesses:

John Lewis: The popular retailer is an excellent example of an EOT – it’s currently 10% EOT-owned. It’s the largest employee-owned company in the UK, with over 80,000 employees. Considering other similar retailers (Debenhams, House of Fraser, etc.) haven’t fared so well during difficult times, John Lewis demonstrates the potential strength of the employee ownership model.

Mott MacDonald Group Ltd: This global engineering consulting firm is a powerhouse in environmental technology. It’s also the second-largest 100% employee-owned company in the UK with 16,000+ employees. The company’s commitment to its employees has shaped its ethos, forming a resilient, motivated, and high-performing company.

Go Ape: Rebecca and Tristam Mayhew founded the popular treetop adventure experience, Go Ape, to balance raising children with running a business. It had always been a personal venture, so they chose to transfer 90% of their stake into an employee-owned trust as an alternative to selling the business. This keeps the business in the hands of its committed employees, rather than private equity.

How Finerva can help

There’s a lot to consider when pursuing an EOT. For example, the company’s governance. Consider how the EOT will run alongside the company, and if there are employee representatives on the board. Establishing an employee council can be an excellent tool for employee communication. The working dynamic between the trustees and the company’s directors should be discussed. Additionally, those considering an EOT must apply to HMRC for tax clearances.

HMRC will decide if the proposed trust qualifies as an EOT. For guidance and advice on EOTs and their tax implications, as well as ensuring you are adhering to HMRC’s rules on trustees, get in touch with our established tax experts.