Employee Ownership Trusts offers possible solution for those hit by Entrepreneurs' Relief cut

Employee Ownerships Trusts could help business owners hit by changes to Entrepreneurs’ Relief in the latest Budget, says Julia Rosenbloom, Head of Private Client Tax Services at Smith & Williamson in Birmingham:

Chancellor Rishi Sunak announced cuts to Entrepreneurs’ Relief, with the lifetime allowance reduced from £10m to £1m. The move followed a review, which found the relief was “expensive, ineffective and unfair.”

In 2017-18, 43,000 individuals claimed Entrepreneurs’ Relief and there are concerns that these cuts will deter aspiring entrepreneurs from starting new businesses and taking those financial risks, knowing there may be a large tax bill at the end. However, entrepreneurs seeking a way out still have options: specifically, Employee Ownerships Trusts (EOTs) can in some cases be an alternative route to a CGT-free exit for shareholders.

The ‘John Lewis’ model

EOTs were introduced by the Government in 2014 to encourage a “John Lewis”-style model of employee ownership. They provide generous tax breaks for existing owners who move to a specific model.

To qualify for the tax incentives, the shareholders of a business must sell shares representing at least a majority stake (51%) to a newly formed trust - the EOT - which will then hold the shares for the long-term benefit of the employees as a whole.

No capital gains, income or inheritance tax liabilities arise on the disposal of a controlling interest in a company to an EOT. Shareholders can still sell their shares for full market value, as they would look to do in a transaction with third parties. Directors with a minority shareholding can remain in their post following the transaction.

Companies controlled by EOTs are also able to pay tax-free cash bonuses to their employees of up to £3,600 per employee per year.

Succession planning

The structure is typically used to create an exit for a majority shareholder who does not want to sell to an external party. As such it is useful in planning succession for family-owned companies where the next generation is not in a position to take over the running of the business; or where entrepreneurs want to retire and realise value but want to see the business continue with minimal interruption.

EOTS have the added incentive of rewarding existing management by allowing them to indirectly own the business they have helped to build. Employees with a stake in the business are generally more productive, with a vested interest in ensuring the long-term success of the company. In this way, EOTs improve staff retention.

While not a good fit for every business, EOTs have been widely used by high profile businesses. Companies such as Richer Sounds and Aardman Animation, the studio behind Wallace and Gromit, have employed this structure.

Lower risk

For business owners who have been banking on an exit from their business at a tax rate of 10%, an exit via an EOT may represent a suitable and tax efficient alternative.

EOTs are a well-established route to a business exit with the added bonus of rewarding existing employees. As such, they should be under consideration by all business owners concerned about the new rules on Entrepreneurs’ Relief.

DISCLAIMER
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of publication.

The tax treatment depends on the individual circumstances of each client and may be subject to change in future.