For employees, the company may pay bonuses of up to £3,600 to each eligible employee per year, free from income tax. National insurance is still payable on these amounts.
It should be emphasised that the CGT relief is a deferral and if the qualifying conditions, particularly the 51 per cent ownership condition is failed, the gain is clawed back.
If the conditions are failed in the tax year of the original disposal or the following year, the deferred gain is taxable on the selling shareholders. If it happens after these two years, the Trustees are treated as selling and immediately reacquiring the shares at market value, thus crystallising a gain.
This is not all about tax reliefs of course. As Graeme Nuttall said in his follow-on report: “Employee ownership is when the employees of a business have both a meaningful ‘voice’ in how the business is run and a significant stake in the success of the business.”
It is important to consider how the employees will have a ‘voice’. There are no prescriptive rules for this. Typically, the governance structure will be as follows:
- The Trading Company will establish a subsidiary company to be the Trustee of the EOT.
- The Trust will be established.
- There will be some form of Employee Council, which will exist to discuss the progress of the business and other relevant issues. Many companies already have some form of employee forum in place.
- The Employee Council may have the right to appoint representatives to the board of the Trading Company. It may also have the right to appoint several directors to the Trust Company. The articles of each company will need to reflect these rights.
- It may also be considered appropriate for there to be an independent director of the Trust Company.
- Other directors to the Trust Company could be appointed by the Trading Company itself.
It is important to recognise that the different parties in this new structure may have different responsibilities. For example, the Trust Company has a fiduciary duty to the beneficiaries, being the employees.
The directors of the Trading Company have a fiduciary responsibility to that company as well as its shareholders.
There are potential conflicts and it would be unwise if the identity of the ‘trading board’ and the ‘trust board’ were identical.
In addition, if the selling shareholders are the sole directors of the Trading Company and the Trustees, or sole directors of the Trust Company, HMRC may have some issues with this when considering any clearance under the transactions in securities rules.
Without going into all the technicalities, the main conditions for an EOT are as follows:
- The Company must be a trading company or the holding company of a trading group. This is the same definition as was used for entrepreneurs' relief.
- The number of continuing shareholders who are directors or employees and all continuing 5 per cent participators (broadly shareholders) must not exceed 40 pre cent of the Trading Company or Group’s total employees. This makes an EOT difficult to establish in a company where there are only a few employees. Persons connected with such shareholders are included for the purpose of this ‘limited participation’ test. The aim of this condition is to ensure there has been a significant change in ownership of the Trading Company.
- Trustees must ensure that all property settled into the EOT is for the benefit of all employees on the same terms.
- The transfer must be of at least a controlling interest, that is greater than 50 per cent, and this must be retained on an ongoing basis. For this purpose, control is on a full economic basis looking at ownership of votes and entitlement to dividends or assets on a winding up.
- The EOT’s assets must be applied only for the benefit of all eligible employees, other than ‘excluded participators’, on equal terms. Eligible employees are those employed by any group member company or the holding company. Distinction may be made between employees based on hours worked, length of service or remuneration. There may also be exclusions for a probationary period (not more than one year) and in certain disciplinary situations). Excluded participators are all 5 per cent or more ‘participators’, including all such participators in the ten years before the commencement of the EOT. These bonuses cannot be used as part of a salary sacrifice arrangement or linked to individual performance conditions. In reality, they should be regarded as a form of profit shares over and above existing remuneration arrangements.
It may be desirable for a few key employees to be given additional incentives, perhaps by way of EMI options. This is possible providing the options are not over shares owned by the EOT. Care should be taken in view of the ownership condition.
It is essential that the EOT controls the Trading Company throughout. Accordingly, where the disposal to the EOT is going to be for say just over 50 per cent of the shares, regard must be had to further diluting events, such as fund raising where shares are being subscribed for or perhaps the exercise of any share options.
A corporate trust is advised as this helps with risk management. An offshore trust company could be considered, as that may give some CGT benefits on a future sale. Using an offshore trust company may mean incurring additional costs.