Vineyard

Tax-free disposals continue to grow in popularity

Shaun Young, Director, Share Plans and Employment Tax
01/10/2021
Vineyard

Business costs, including National Insurance, are on the rise. Tax uncertainty caused largely by pandemic-related government expenditure has caused business owners to re-examine their plans for retirement. Last year’s reduction to the Entrepreneurs’ Relief (now Business Asset Disposal Relief) has made some exit routes more expensive. The 2020 Budget introduced an overnight reduction to the lifetime limit from £10 million to £1 million. For some this is a substantial increase in an individual’s Capital Gains Tax (CGT) liability on the sale of their business, as a greater proportion of their gain is taxed at the higher 20% rate. Also, The Office of Tax Simplification has been consulted on further changes which might even see an alignment of CGT rates with income tax top rates (up to 45%) in future Budgets.

For family businesses, this increase could delay retirement and succession into the medium term. Company owners looking for an alternative solution may wish to consider an Employee Ownership Trusts (EOT). In 2014, the government introduced significant incentives to encourage businesses to adopt an employee ownership model. According to the Employee Ownership Association, at the last count there are some 730 employee-owned businesses. With the 2021 growth in numbers exceeding 2020 - which was itself a record year – something is on the move. Where certain criteria are met, the disposal of shares to an EOT is completely exempt from CGT.

Criteria

  • The EOT must acquire a controlling shareholding in the company (>50%).
  • The company must be a trading company or the holding company of a trading group.
  • The EOT must be set up for the benefit of all eligible employees.
  • Following the disposal, the number of employees/directors who continue to hold at least 5% of the company’s shares must not exceed 40% of the total number of employees.

How does it work?

The shares can be sold to the EOT for up to market value and these are held by the trust for the benefit of the employees.

In many cases, there will be insufficient cash in the company to fund the full proceeds up front. Instead, an initial consideration sum may be paid over with the balance owing as debt and paid by the EOT out of future cash flow. Some of the consideration may be borrowed by the trading company and contributed to the EOT for this purpose.

How do employees benefit?

EOT disposals can be viewed as partly philanthropic – depending on the price charged. In addition, employees who remain can benefit via tax-favoured bonuses; as an EOT is able to pay up to £3,600 per year to each employee tax-free. There is some flexibility on the level of bonus per employee, depending on remuneration, length of service and hours worked.

Share incentive plans may also be put in place, alongside the EOT, to incentivise senior management.

Is an EOT the right choice for a Family Business?

Of the various advantages of an employee ownership model, the creation of a ‘friendly’ purchaser rather than an unknown third party, may be of particular appeal. Although the legislation has been around for some time the EOT model still feels relatively new.  There is a view that the cooperative feel of the new structure incentivises employees to commit themselves to the business for the longer term. If so, this can help safeguard the future of the business as an entity, which is often a concern for retiring founders.

The flexibility of the seller being able to retain a shareholding/role in the company may also be useful for those looking for a phased withdrawal. Similarly, not all shareholders necessarily need to be involved in the sale, as long as the EOT acquires a majority interest.

The employee ownership route will certainly not be for everyone. While the upfront advantages may seem attractive, in a family context EOT could make succession for the next generation more complex.

Should you have any queries, or wish to discuss this further, please get in touch with your usual Crowe contact.

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Shaun Young
Shaun Young
Director, Share Plans and Employment Tax
London