What is Employee Ownership Trust and How Does it Work?

Imagine a company where everyone, from the CEO to the newest hire, has a real stake in the business. A place where success is shared and employees feel genuinely invested in the company’s future. Sounds like a dream? Not so fast.

Employee Ownership Trusts (EOTs) are making that a reality for businesses across the UK. And though the idea of employees owning a piece of the pie is inspiring on its own, there’s another big perk: tax benefits.

What is an Employee Ownership Trust?

An EOT is a special kind of trust that buys shares in a company and holds them on behalf of its employees. Instead of selling the business to an outside buyer or passing it on to the family, the owner sells their shares to the trust. This means the employees, as a group, become the company's owners.

It’s a way to keep the business in the hands of the people who know it best and those who’ve helped build it. But it gets even better: EOTs come with serious tax advantages for employees and business owners.

Tax Perks for Employees

One of the coolest things about EOTs is that employees can receive tax-free bonuses. Each year employees can get a bonus of up to £3,600 without paying a penny in income tax. But though the bonus is tax-free, National Insurance contributions still apply.

Tax Breaks for Business Owners

For business owners thinking about selling their company, EOTs provide a great advantage: Capital Gains Tax (CGT) relief. Normally when you sell shares in a business, you’d have to pay CGT on any profit you make.

But with an EOT if you meet certain conditions, you can sell your shares to the trust without paying a single penny in CGT. That’s a huge saving for owners of successful businesses.

Here’s how it works: when you sell your shares to the EOT, the trust takes over the “base cost” of those shares. This means the trust steps into your shoes and you walk away with the full value of your shares, with no tax bill attached.

But the relief only applies in the tax year when the EOT takes control of the company. Any sales before or after that year are taxed as usual.

What You Need to Know About the Rules

To qualify for those tax benefits, a few conditions need to be met. Here’s a rundown:

• The Trading Requirement - The company must be a trading business or the parent company of a trading group. Non-trading activities are allowed but can’t make up more than 20% of the business.
• The All-Employee Benefit Requirement - Every employee must be eligible to benefit from the trust and the benefits must be distributed fairly. This doesn’t mean everyone gets the same amount but the rules should be based on factors like salary, hours worked, or length of service.
• The Controlling Interest Requirement - The EOT must gain control of the company in the same tax year the shares are sold. If you sell only part of your shares, any future sales won’t qualify for the tax relief.
• The Limited Participation Requirement: In the year leading up to the sale no more than 40% of the company’s employees can be “participators” (that is, people who own shares or have big influence). This means the trust benefits all employees, not just a select few.

New Rules on the Horizon

The government is also introducing some new requirements to make sure EOTs are used fairly and responsibly. For example:

• The trustees must be UK residents.
• The original owners can’t control the trust after the sale.
• The price paid for the shares must be fair and not outstrip market value.
• Sellers must provide details about the sale and the number of employees when claiming tax relief.

All these are meant to prevent abuse of the system and benefit everyone involved.

Why EOTs are Worth Considering for Businesses

For business owners EOTs provide a way to exit the business on their own terms, reward the employees who helped build it and save on taxes. As for employees, it’s a chance to share in the company’s success and feel more connected to their work. And for the business itself, it means stability and continuity for the future.

Of course, setting up an EOT isn’t something you can do overnight. It demands planning and professional advice. Even so, the benefits far outweigh the effort for many businesses.

Conclusion

Employee Ownership Trusts help create a fairer, more inclusive way of doing business. Giving employees a stake in the company can boost morale, drive productivity and possibly set the stage for long-term success. And with the added bonus of tax relief for employees and business owners, it’s no wonder more and more companies are making the switch.