How employee ownership trusts work

  • Describe how employee ownership trusts work
  • Identify some of the rules surrounding them
  • Describe how EOTs work for employees
How employee ownership trusts work
Simon Dawson/Bloomberg

Employee participation has been seen as beneficial for business and society for many years. 

Successive governments have made the widening of share ownership among employees more attractive by introducing tax approved share schemes. Some of the schemes are discretionary and are only intended for key employees while others are all-employee schemes.

To date, the most popular scheme has been the Enterprise Management Incentive. 

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This has been the most flexible and with the most generous tax rules. Although this is discretionary, it can be used for all employees subject to the limits of the scheme.

The introduction of a corporation tax deduction for companies providing share incentives made them even more attractive.

Reference is often made to the ‘John Lewis’ model where shares are owned by trusts for the benefit of employees. 

Business leaders and professionals have lobbied government for the introduction of some form of tax relief to encourage a similar model. This resulted in the Coalition Government commissioning the Nuttall Review.

Tax legislation was introduced in 2014 to establish the tax incentives for Employee Ownership Trusts (EOTs). Although there was a slow take up, in the last two years, they have become much more mainstream and many businesses see this type of structure as the way forward.

But how does this fit in with succession planning? 

Succession planning

Traditionally, leaving aside situations where businesses are sold to a third party, succession has normally been by way of either family or some form of takeover by management. 

Often, as far as management buyouts are concerned, this has been facilitated by giving the management teams an initial stake in the ownership of the company through share incentives, most probably EMI.

The MBO model is, however, not without its difficulties.  If this is to be a leveraged buyout, that is with third party debt, there is an expectation that the management will contribute a significant amount towards the capital as ‘hurt’ money. 

It is often the case that management will not necessarily have the wherewithal or the appetite for contributing capital. In short, the traditional leveraged MBO has become more problematic. The current C19 crisis does not help.

It should not be assumed that the desire to sell to an EOT is contemplated simply because other routes are unavailable. Many business owners see that leaving the business in the hands of employees as their preferred way forward for reasons that are more philosophical.

Whatever the reasons a company’s directors may have for establishing an EOT, the tax reliefs are significant. For the shareholders, the transfer of shares by shareholders into the EOT is free from capital gains tax (CGT).

This will be of particular interest to shareholders who may not benefit from business asset disposal relief (previously called entrepreneurs’ relief).  In addition, there should also usually be 100 per cent relief from inheritance tax that would otherwise apply to transfers of shares.