Changes to the Taxation of Employee Ownership Trusts

October’s Budget included several targeted reforms to the Employee Ownership Trusts (EOTs) tax reliefs.

The reforms follow the 2023 consultation on Taxation of Employee Ownership Trusts and Employee Benefit Trusts and have been introduced to ensure available reliefs meet their intended purpose of rewarding employees and encouraging employee engagement, whilst preventing opportunities for tax avoidance.

The changes came into effect from 30 October 2024.

Summary of the key changes

Capital Gains Tax Relief

Measures introduced make changes to the conditions for obtaining relief from Capital Gains Tax on disposal of a controlling shareholding in a company to the trustees of an EOT by:

• Former owners, or persons connected with former owners, are now restricted from retaining control of companies post-sale by virtue of control (direct or indirect) of the EOT;
• Trustees must now take ‘reasonable steps’ to make sure that the consideration paid to acquire the company shares does not exceed market value;
• Trustees must be UK resident at the time of disposal to the EOT;
• Individual vendor’s claim for Capital Gains Tax relief must include information on the sale proceeds and the number of employees of the company at the time of disposal; and
• Extension to the ‘vendor clawback period’, within which the tax-relieved can be recovered from the vendor if the EOT conditions are breached post-sale, to the end of the fourth tax year following the end of the tax year of disposal.

The changes to the Capital Gains Tax claim conditions will have effect for claims made for the tax year 2024-25 onwards.

Income Tax distributions

A new Income Tax relief will apply to contributions paid to the trustees of an EOT, including consideration that is then repaid to the former owners in return for their shares, and contributions to cover associated costs such as stamp duty and interest paid at a reasonable commercial rate. This gives legislative confirmation of the treatment that is currently routinely confirmed through clearance applications.

Income Tax and annual bonuses

Amendments have been made to allow for the exclusions of directors from the ‘participation requirement’ for the purposes of determining whether Income Tax relief is available on annual bonus payments made to employees of EOT owned companies.

Inheritance Tax

Three changes have been made to the conditions that need to be met for a transfer into an Employee Benefit Trust to be exempt from Inheritance Tax:

• The restrictions on connected persons benefiting from an Employee Benefit Trust must apply for the lifetime of the trust;
• Restrict the Inheritance Tax exemption to where the shares have been held for two years prior to settlement into an Employee Benefit Trust — where there has been a share reorganisation, the shares previously held will be taken into account in considering the two-year holding period; and
• Ensure that no more than 25% of employees who can receive income payments should be connected to the participator in order for the Employee Benefit Trust to benefit from favourable tax treatment.

How M+A Partners can help

EOT’s are increasing in popularity as a means for shareholders exiting a business whilst preserving a legacy to the employees who have helped shape it.

The changes announced in the Budget have been pending for some time and primarily act against those HMRC see as abusing the legislation.

For shareholders who want to realise value and secure an opportunity for all employees to participate and benefit from company ownership, a sale to an EOT at 0% tax rate remains a rewarding exit.

If you would like to learn more about EOT’s please contact me using the details below.