Unlocking value for shareholders retiring in a covid world

The economic impact of the COVID-19 pandemic may in some cases make it more difficult for company owners approaching retirement to successfully exit and retire from their business.

The likely reduction in the number of prospective buyers willing to acquire businesses will inevitably limit the means by which owners can effect a financially beneficial exit whilst, ensuring that there is a continuing business for its employees.

One potential exit route which should come under increasing consideration as a means of seeking to achieve these objectives is a company sale to an Employee Ownership Trust (“EOT”).

EOT’s have been around for a long time, and in 2014 an attractive tax regime was introduced for substantial share sales to EOT’s. Whilst the take-up and transition to this form of company ownership has been gradually increasing since the introduction of this tax regime, its take-up across the whole of the UK has not been consistent. It should be noted that a recent survey conducted by RM2 indicated that its popularity within the East of England region was still low compared to other regions of the UK such as Scotland.

What is an EOT?
An EOT is a specific type of employee benefit trust which must be established for the benefit of all employees. The terms of the EOT are set out in the form of a Trust Deed. Individuals or corporate bodies are appointed as trustees of the EOT to represent and manage the interests of the employees.

What are the tax benefits of selling their shares in a business to an EOT?
Capital Gains Tax (“CGT”) relief is available to an individual who sells shares in a company to an EOT. The disposal is treated as made on a no gain/no loss basis with the effect that no CGT liability is triggered. Consequently, it represents a tax exemption.

As you might expect there are a number of conditions which must be met for the CGT relief to be available.

These include:

• The company must be a trading company when the disposal occurs and must remain so throughout the remainder of that tax year
• The EOT must benefit all employees of the company
• The EOT must not own a controlling interest in the company immediately prior to the start of the tax year in which the disposal occurs but must own a controlling interest at some point during that tax year
• The “limited participation” requirement must be met. This requirement imposes a condition that the number of individuals who are both 5% shareholders and employees or office holders (including connected persons who are employees or office holders) compared to the total number
  of employees of the company must not exceed 2/5ths within the 12 months leading up to the disposal and throughout the remaining period of the tax year in which the sale occurs.

The disposing shareholder must report the disposal on the Capital Gains pages of his or her tax return and claim the relief. This relief can be clawed back if a particular event occurs in the following tax year.

Income tax exemption is also available on certain bonus payments made to employees by the EOT (up to £3,600 per employee per tax year).

What are other benefits of an EOT?
It gives the employees a controlling stake in the business (via the EOT) and also representation at Board level. It also provides the opportunity for the retiring business owner to leave a legacy and to ensure that the interests and needs of their loyal employees are preserved and looked after.

How can the EOT finance the purchase?
There are a number of ways in which an EOT deal can be financed. However, ultimately the funds are likely to need to come either directly from the company (via a contribution or loan to the EOT) or via security given to a lending bank over the company and its assets. There is also a possibility that an individual shareholder may be prepared to sell shares to the EOT on deferred payment terms so that the consideration of the sale is paid in instalments.

Careful structuring and thought will need to be given to the financing arrangements to ensure that they do not adversely affect the company’s ability to borrow in the future, or that the financing terms do not inadvertently breach the necessary conditions to obtain the CGT relief.