31/07/23

TRUSTS: HMRC moves to close Employee-Owned Trust loopholes

As published on: insidermedia.com, Monday 31 July, 2023. 

Following a recent publication by HMRC of the promised consultation document on changes they want to make to Employee Ownership Trusts, Chris Blundell, Partner at MHA, says the changes are reasonable and expected, but do mean the opportunities for a sale to an EOT will be more restricted for business owners and could mean employees will be worse off in certain circumstances.

“HMRC is proposing changes to the currently very popular and tax-effective tax regime on Employee Ownership Trusts (EOTs). EOTs mean owners don’t have to pay capital gains tax if they sell at least 50 per cent of the business into an EOT which has the company’s employees as its beneficiaries.

“The changes are intended to tighten up the EOT regime to ensure the relief on EOTs does more to encourage employee ownership rather than allow the owners to avoid capital gains tax. We should be planning for these changes to come into effect as soon as the government can manage: so probably 6 April 2024.

“The changes make sense and are reasonable but they could make a sale to an EOT more restricted for some owners making it more difficult for them to influence the company after the sale to an EOT. From a tax perspective, the proposed prohibition on allowing EOT’s to have non-UK resident trustees may well make the employees of the company worse off in the future were the EOT to sell its company shares in the years to come.  Anyone who has been planning to sell their company to an EOT should therefore be planning on doing this sooner rather than later. 

“You should certainly be aiming to get the sale to the EOT completed by March next year if you want to take advantage of the current EOT regime, particularly if you were considering using offshore trustees for the EOT.”

The principal changes contemplated by HMRC are:

“Trustees:  At present, even though they must sell more than 50% of their company to an EOT to benefit from the EOT tax reliefs, the former owners of the company can maintain some level of control over their company by being on the EOT’s board of trustees. 

“HMRC are concerned that owners may keep de facto control of their company if they form the majority on the EOT’s board of trustees.  Therefore, HMRC are proposing that the legislation is amended to require that more than half of the EOT’s board of trustees are persons other than former owners or people connected with them. 

“Tax residency of the EOT: The proposal in the consultation document is that the EOT to which the individuals sell their shares must be UK resident for the sellers to qualify for their CGT tax reliefs.  This change is entirely understandable.  It has always been thought extremely generous that there was nothing in the legislation requiring that the EOT to which the company was to be sold was UK resident.

“Contributions to the EOT from the sold company:  This change is rather complex but it is actually good news. Most EOT transactions are structured such that the sale is on deferred terms.  For example, a company is worth £10m.  It is agreed that 100% of this company is to be sold to the EOT for £10m with £2m paid upfront and the remaining £8m being paid over the next 5 years. 

“The EOT has no cash or assets itself when it is first set up.  The sum it has agreed to pay for the company is usually funded by voluntary contributions to the EOT from the sold company out of its built-up distributable reserves and future profits.  Strictly, these contributions from the company to the EOT are dividends on which the EOT trustees should have to pay dividend income tax whether they were UK resident or not. 

“However, to date HMRC have given concessional clearances so that such payment is not treated as a taxable dividend of the EOT trustees. 

“As had been requested by the Chartered Institute of Tax amongst others, the government is now proposing to amend the UK’s tax law so that payments made by companies to EOTs in these situations will not be treated as taxable dividends provided the price the EOT agreed to pay for the company was not more than its market value.  This is good news.  Advisers do not like relying on concessional tax reliefs given by HMRC which can be withdrawn at any time.” 

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HMRC Trusts EOTs