Where the circumstances are right, and subject to certain qualifying conditions being satisfied, it is possible for a controlling shareholding in a trading company (or group) to be sold to an EOT with no Capital Gains Tax being payable by the sellers. EOTs, together with this generous tax relief, were introduced by the Government in 2014 with the aim of further promoting employee-ownership of businesses; this being supported by research as generally leading to higher levels of productivity and engagement.
An EOT-controlled company is also able to pay bonuses of up to £3,600 per employee each tax year which are exempt from income tax.
It is relevant to individual shareholders of private trading companies who are contemplating a sale of the company. There is no restriction on the size of the company’s balance sheet or turnover, the nature of the company’s trading activities, the sector it operates in or even where it is based geographically. There are also no limits on the percentage or value of shareholding held by the individual, unlike other tax reliefs.
The regime is not applicable to non-trading companies (companies that receive passive investment income or have ceased trading) or available to companies that have a low number of employees relative to the number of shareholders. It is also only applicable to companies, so businesses that are currently structured as sole trader enterprises or partnerships would not directly qualify without a prior reorganisation.
In addition to the headline tax relief for sellers, an EOT sale is designed to offer a relatively easy and quick transaction process compared to alternative routes, typically with lower professional fees being incurred. Sellers also tend to favour an EOT sale if other routes have not been successful previously (aborted deals), do not align with their wishes (e.g. no desire to sell to a competitor corporation) or their objective is to specifically ensure the ownership of the business is passed on to all the employees.
In addition to the requirements for the company to be trading and to have a threshold number of employees, sellers qualify for the Capital Gains Tax-free treatment if a controlling shareholding is sold to the EOT (broadly, 51% or more of the share capital and voting power in aggregate).
Further, the EOT must be constituted through a special form of trust deed to comply with specific legal requirements concerning how the EOT operates to ensure that all employees of the company benefit on an equal and fair basis (subject to a few exceptions).
The general features of any company sale event then form part of the process, including independent valuation assessment of the company, negotiation and agreement of sale terms and execution of transaction documents including a Sale and Purchase agreement.
Sellers need to ensure that their personal tax return for the tax year in which an EOT sale takes place contains specific disclosures and a statutory claim for the Capital Gains Tax-free treatment.
Finally, it is important to note that if any of the qualifying conditions cease to be met following the EOT sale, the tax treatment changes. If this happened before the end of the tax year following the tax year in which the EOT sale took place, the sale to the EOT becomes fully chargeable to Capital Gains Tax on the sellers. If the disqualifying event happens after this date, Capital Gains Tax is charged on the EOT itself at that point.
What should you do next?
While the opportunity to sell a company tax-free to an EOT is clearly an attractive reason to consider this, it is important that tax itself does not drive the agenda. Sellers need to explore and weigh-up alternative sale strategies, including selling to either a corporate/trade buyer, to a private equity/venture capital investor or to a senior employee team directly through a management buy-out. Consideration of the wider commercial factors and the other parties involved is critical to this process. In the right set of circumstances, however, it delivers an excellent exit strategy for the sellers and a real opportunity for employee ownership going forward.