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Employee Ownership Trust – Qualifying Conditions for the Different Tax Reliefs

Previously, we outlined how an Employee Ownership Trust (EOT) could be used for succession planning and some of the key benefits of implementing an EOT structure.  In this article, we consider some of the key conditions that have to be met to secure the favourable tax reliefs that are available.

Capital gains tax exemption

One of the attractions of selling shares to an EOT is that the sale should be completely free of Capital Gains Tax (CGT). For this generous relief to apply, there are various conditions that must be met as detailed below.

  1. Trading requirement – The company whose shares are transferred to the EOT must be a trading company or the holding company of a trading group;
  2. Controlling interest requirement – The EOT must not hold a controlling interest in the company before the transfer, but must hold a controlling interest at the end of the tax year in which the transfer takes place;
  3. All employee benefit requirement – Any benefit to employees must be on the same terms for all eligible employees. Benefits can only be allocated in differing amounts according to factors such as length of service and salary;
  4. Limited participation requirement – This limits the continuing involvement of the ‘selling shareholders’ by requiring that the number of continuing shareholders who are directors or employees (and people connected with them) must not exceed 40% of the total number of employees of the company or group.

In structuring a sale to an EOT, it is essential that the above conditions are considered fully to ensure the valuable CGT relief is secured.

Income tax exemption

In addition to the CGT relief that is available on the sale to an EOT, there is a valuable Income Tax exemption that applies where a company is controlled by an EOT.

Typically, bonus payments made from employers to their employees are subject to income tax at rates of up to 46%, as well as being liable for National Insurance.  However, a company controlled by an EOT can make qualifying bonus payments of up to £3,600 per employee per tax year and these will be exempt from Income Tax (but not National Insurance).

To qualify for this Income Tax exemption, the above EOT conditions, together with the following:

  1. the bonus cannot consist of regular wages or salary; and
  2. all employees must be eligible to participate in the bonus scheme.

Although tax should not be the sole driver in deciding whether to move to an EOT structure, these reliefs boost the appeal of moving to employee ownership by offering the selling shareholders, and the company’s employees, valuable tax savings. However, given the number of strict conditions that are required to be met, it is crucial that the sale is structured correctly in order to make use of these reliefs.

For more information, or to discuss your circumstances, please contact our Employer Solutions team.

In our next article, we outline how the transition to an EOT may be structured and discuss how the selling shareholders can realise funds. You can also read our previous article on ‘A Strategy for Business Succession’ here.

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