The Employee Ownership Trust and other taxes
The EOT was set up by the government to encourage employee ownership and the government decided to use tax-incentives as a key motivator for business-owners like you to take this route.
In this article, we delve into the tax advantages, particularly focusing on the pivotal role of Capital Gains Tax (CGT) and Inheritance Tax (IHT).
Understanding Capital Gains Tax in Business Sales
Capital Gains Tax (CGT) is a financial consideration that comes into play when selling an appreciating asset, such as shares in a business. When conventional exit strategies involve a trade sale, private equity-backed purchase, or management buy-out, the gain from the increased value of shares triggers CGT. The standard CGT rate can be as high as 20%, or 10% with Business Asset Disposal Relief (formerly Entrepreneurs’ Relief) available on the first £1m.
The Tax Efficiency of Employee Ownership Trusts
Selling a controlling stake in your business to employees through an EOT is a game-changer in the tax landscape. The most significant advantage for the exiting shareholder lies in the effective exemption from Capital Gains Tax. This positions the EOT as a remarkably tax-efficient method for business owners looking to transition while securing financial benefits.
Comparative Tax Efficiency: EOTs vs. Traditional Routes
In contrast to the standard CGT rates, the profits from selling to an EOT are effectively exempt from Capital Gains Tax. The normal CGT rate of 20%, or 10% with Business Asset Disposal Relief, pales in comparison to the tax efficiency offered by an EOT. This distinction makes the EOT an attractive option for those seeking to maximize their financial gains during the business selling process.
Inheritance Tax Benefits with EOTs
Beyond Capital Gains Tax advantages, Employee Ownership Trusts also provide benefits in relation to Inheritance Tax (IHT). The sale of shares to a trust at less than market value can trigger immediate IHT liabilities for the seller, but an exemption applies when the sale is to a qualifying EOT. This makes the EOT route a reassuring choice for business owners concerned about potential Inheritance Tax implications.
Qualifying for Capital Gains Tax and Inheritance Tax Exemptions with an EOT
While the tax benefits are enticing, it's essential to meet specific conditions to qualify for the effective EOT Capital Gains Tax and Inheritance Tax exemptions:
1. Trading Company Status
The company must operate as a trading company or serve as the holding entity for a trading group.
2. Inclusive Employee Benefits
The EOT must benefit all employees, excluding those who have been 5% participators in the company within the past 10 years.
3. Controlling Stake
The EOT must hold a controlling stake in the company post-acquisition.
4. Employee-Shareholder Ratio
Employees with over a 5% personal interest in the company, also serving as shareholders, should not constitute more than 40% of the total workforce.
5. Equal Employee Benefits
The EOT must extend benefits to employees on principally equal terms.
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