In 2014, the UK government introduced employee ownership trusts (EOT) to encourage more businesses to consider employee ownership, which provides a stable and sustainable ownership base for UK businesses.

EOT’s attract certain tax reliefs for both the selling owners (100% relief Capital Gains Tax on the sale of their shares to an EOT), and the employees of an EOT owned business (income tax-free cash bonuses of up to £3,600 per employee per year), making employee ownership a more attractive option for ownership succession.

The requirements for both reliefs are similar, but there are some requirements that only apply to one and understanding whether your business can qualify for both will be vital if you are considering transitioning your business to employee ownership.

CGT Tax Relief for exiting owners

For business owners looking to sell to an EOT, to qualify for full relief against capital gains tax the following conditions need to be met on the date the sale completes:

1. All-employee benefit requirement: any distributions the EOT makes (for example, the distribution of assets on a winding up) to be applied for the benefit of all eligible employees of a company on the same basis, but the EOT can differentiate between employees based on their salary, hours worked, or length of service.
2. Controlling interest requirement: once the shares have been sold to the EOT, it must have a controlling interest, on an ongoing basis, which means the EOT will always need to meet all of the following requirements:
   • hold more than 50% of the shares in the company;
   • hold a majority of the voting rights in the company;
   • be entitled to more than 50% of the profits available; and
   • be entitled to more than 50% of the assets on a winding up.
3. Trading requirement: the company whose shares are transferred to the trustee(s) of an EOT must either be a trading company or the holding company of a trading group.
4. Limited participation requirement: the number of shareholders with more than 5% of any class of share, who are directors or employees (and any persons connected with them who is a director/office holder or employee) must not exceed 40% of the total number of employees of the company or group. For example, if a director/office holder or employee holds 6% of a class of Ordinary A shares, even if these shares are only 1% of the overall share capital of the company, this individual would still be treated as a limited participator.
5. Trustee Independence: the trustee of the EOT must remain independent. This means ‘Excluded Participators’ (being sellers and any connected parties such as family members, 5%+ shareholders, the board of the trading company itself if 50% or more of the board are excluded participators) cannot make up 50% or more of the EOT’s trustee board.

Note that the capital gains tax relief only applies to sales made to an EOT in the first tax year of its existence. Any subsequent sale of shares to the EOT would attract capital gains tax as normal.

Income tax relief on bonuses for employees

Once a business becomes employee-owned, one of the many benefits of being employee owned is that employees can receive income tax free bonuses.

For employees to receive income tax free bonuses in an EOT business, the following conditions need to be met:

1. The participation and equality requirement: with a few exceptions, all employees must be able to participate in the bonus and every employee who participates in the bonus scheme must do so on the same terms, but you can differentiate in relation to salary, hours worked, or length of service.
2. The officeholder requirement: The ratio of the number of directors/officers to total number employees of the company (including directors/officers) should not be more than 2/5 for the time period the bonus relates to.
3. The indirect employee-ownership requirement: the controlling interest requirements of the company or group of companies set out above, must be held by an EOT for the time period the bonus relates to.
4. Trading requirement: the company must have been a trading company or a member of a trading group for the time period the bonus relates to.
5. £3,600 Limit: The maximum bonus payable to an employee each year is £3,600 (all of which is income tax free, but national insurance contributions are payable).
6. Further conditions: The bonus payment should be made from profits, not as regular wages or salary, and the payment should not be made by a service company.

It is worth noting that the company may pay discretionary / performance related bonuses to employees separately as before, there are no limits placed on this. These discretionary bonuses would attract income tax as normal.