A Guide to Employee Ownership Trusts (EOTs)

A Guide to Employee Ownership Trusts (EOTs)

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We are hearing more and more about Employee Ownership Trusts (EOTS). But what are they, how could they work within your business and what do you need to know?

An EOT is a unique trust structure that enables companies to hold shares on behalf of their employees, providing them with a direct stake in the company’s success. It is designed to foster a sense of ownership among employees, which can lead to increased motivation, productivity, and job satisfaction. The key behind any pioneering business!

Below is a guide we have put together on Employee Ownership Trusts covering:

  • Succession planning
  • Valuation of shares
  • Distributing profit
  • Repayment of tax
  • EOT and loan financing

Employee Ownership Trusts and Succession Planning

An EOT can serve as a strategic tool for succession planning, as it allows for a smooth transfer of ownership from the existing owners to the employees over time. The benefit of this? By gradually transferring ownership through an EOT, companies can ensure continuity and stability while also providing for the long-term interests of their employees. 

If a majority stake in a trading company is transferred to an Employee Ownership Trust (EOT) and certain qualifying criteria are met, the seller may be eligible for capital gains tax reliefs. The Employee Ownership Trust structure also allows for the payment of tax-free bonuses to employees, up to a limit of £3,600 annually. This incentivises employees to work towards the success of the business while providing tax benefits for both the seller and the employees.

Succession planning via EOTs can allow business owners to pass ownership of the company to employees of the company without incurring a Capital Gains Tax charge. Capital Gains Tax would normally be charged at:

  • Basic Rate: 10% or 18%
  • Higher or Additional Rate: 20% or 28%

Employee Ownership Trusts and Valuation of Shares

Before going forward with the sale of an EOT, it is important to accurately establish the value of your business’s shares. If a company is sold higher than its market value, this may incur a tax rate of up to 45%. This is assuming that the shares originally attached to the company were employee related securities.

We would advise you to seek a valuation from an independent third party, as there is a standard way of agreeing a business’s valuation with HMRC. If you’re looking for a dedicated team to accurately value your company, get in touch with the OutRise team. Or if you’d like to get a rough idea of your business’s value as a starting point, use our business valuation calculator:

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Distributing Profit After an Employee Ownership Trust

Dividends paid on shares held by employees:

When employees are owners of shares of a business via an Employee Ownership Trust where dividends are paid, any profits that are dispersed by the company will be paid to trustees. These profits will be subject to tax, although the first £2,000 of any dividend income will be taxed at 0% (in the 2021 – 2022 tax year).

If trustees of the Employee Ownership Trust waive their entitlement to dividends on shares within the EOT, this will increase the amount of profits that are available for distribution to employee shareholders. This will also be paid out via dividend.

Dividends paid to the Employee Ownership Trust trustees:

Below are the allowances and rates as of the year 203 – 204:

  • Trustees are not entitled to personal allowances
  • Trustees are not entitled to the starting rate band or the savings allowance
  • Trustees are not entitled to the £2,000 dividend allowance
  • Dividend income, within the £1,000 limit, is taxed at the dividend ordinary rate of 8.75% (8.75% for 2023–24)
  • All other types of income within the £1,000 limit are taxed at the basic rate of 20%
  • Dividends income, over the £1,000 limit, is taxed at the dividend trust rate of 39.35% (39.35% for 2023–24)
  • all other types of income over the £1,000 limit is taxed at the trust rate of 45% (for 2023–24).

Payments to employees by the EOT trustees via dividend income:

Payments made to employees via an Employee Ownership Trust will be charged to income tax and national insurance contributions as employment income from their company. This will be due under PAYE (Pay As You Earn).

The trustees that are making these payments to employees must make sure these payments come through the employer’s payroll.

Alternatively, the trustees may have to put arrangements in place to deduct from the payment and remit to the employer an amount equal to the income tax and NICs that the employer is required to pay to HMRC under the Pay As You Earn scheme. This ensures that the employer is fully reimbursed for any tax and NICs owed in relation to such payments.

Employee Ownership Trusts and Loan Financing

When lending to a company owned by an Employee Ownership Trust (EOT), lenders must consider certain issues. 

Cannot grant security or guarantees on money they aren’t borrowing:

Employee Ownership Trusts are actually prohibited from granting security or guarantees on any money they are not borrowing. As a result, security over the shares held by the EOT cannot be granted.

No funds, just shares:

Employee Ownership Trusts have no funds other than company shares but will still owe money to their lender. Although security provisions can reduce this impact.

If the employee-owned company borrows money itself and contributes funds to the EOT, the company’s borrowing capacity and distribution reserves may be limited.

Scrutinisation:

Lenders must scrutinise and question the security packages and deal structures when lending to a company. Certain conditions should be included within the agreements to enable the company to fund the Employee Ownership Trust with the money they receive.

Overall, lending to a company owned by an EOT requires careful consideration of various legal and financial issues, and lenders should assess the situation carefully before proceeding.

Is an Employee Ownership Trust right for your business?

It’s not easy determining whether your business is the right fit for an Employee Ownership Trust. At OutRise, our team can help you consider all possibilities and aid you in finding the most beneficial path forward for your business.

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