Since the introduction of Employee Ownership Trusts (EOT) in tax legislation seven years ago, do they remain a credible alternative to a Management Buyout?
The seventh anniversary of a relationship can be associated with the decline of happiness as each party re-evaluates the other. The same cannot currently be said for the Employee Ownership Trust (EOT) regime introduced into tax legislation seven years ago with great fanfare.
EOT’s appear to be gathering momentum, spurned on prior to March 2021 by rumours of increases to the rates of Capital Gains Tax (CGT) in the March 2021 Budget with company owners and advisers appreciating the merits of the CGT deferral relief for capital gains made on the qualifying sale of a controlling interest in their company’s to the Trustees of an EOT.
Where implemented correctly, an EOT represents a credible alternative to a management buyout (MBO), with the above CGT advantages for the vendor and, subject to certain conditions, the potential to pay tax-free bonuses of up to £3,600 per annum to employees.
However, the use of an EOT is not necessarily without risk of challenge by HM Revenue & Customs (HMRC) as the EOT legislation can be a difficult minefield to navigate.
For example, the price paid by the Trustees of the EOT for their controlling interest must be made as a bargain at arms-length and cannot be more than the “price which those assets might reasonably be expected to fetch on a sale in the open market”. The purchase price will also need to take account of future company obligations if the purchase price, funded by the company, is deferred.
Furthermore, assuming that the vendor holds employment related securities, to pay that vendor an amount in excess of the market value creates an immediate income tax and National Insurance Contributions liability due under PAYE on the excess above market value. Trustees also have fiduciary duties to act in the best interest of the Trust’s beneficiaries and therefore should not pay more than market value.
Unlike approved share schemes, such as EMI, SIP or SAYE, there is no mechanism to seek HMRC’s agreement to the market value of a company for EOT purposes either before or after the transaction.
It is therefore best practice that prior to the sale of shares to an EOT that an independent valuation of the company is sought on which the directors and Trustees can base their decisions to fund and to purchase respectively.
Such valuation should also be referred to within any clearance application submitted to HMRC seeking approval for tax purposes of the arrangement.