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Over the past year, a number of high profile companies – Richer Sounds being perhaps the most prominent – have indirectly transferred shares in their companies to employees as part of a long term succession plan, using an employee ownership trust (EOT). According to the Employee Ownership Association (EOA), over 350 businesses have now adopted the EOT model, with at least 50 more preparing to follow suit.
Many companies offer tax efficient share option schemes like the enterprise management incentive (EMI) scheme, whereby key employees are granted options to buy shares for a pre-agreed amount, which they are later able to sell in the event of a sale of the company for example. Employee ownership trusts – the model adopted by John Lewis – work differently, and whilst they may be more tax advantaged, they require the involvement of all employees.
With annual sales of nearly £200m, Richer Sounds is one of the biggest UK companies to embrace employee ownership in recent years. Other recent converts include Riverford, the organic vegetable box subscription service and Aardman, the Bristol-based animation studio behind Wallace & Gromit. In the case of Richer Sounds, founder Julian Richer gifted 60% of his shares to a trust for the company’s employees, each of whom will effectively receive £1,000 in value for every year of service. It will mean on average each employee receiving shares with a value of £8,000, with some getting significantly more.
Background to EOT
The EOT legislation was introduced in the 2014 Finance Act to provide retiring entrepreneurs with a new exit route and new opportunities for succession planning. By creating a trust to which they sell a controlling percentage of company shares, the shareholder can continue to receive regular returns whilst ensuring the company retains its independence after their departure. Importantly, it protects employees from the threat of uncertainty in the event of a change in ownership; for instance if the remaining shares are sold to a private equity company or a competitor.
Typically, where a company has an employee ownership trust in place, it will build up a pool of surplus funds generated from accumulated profits over several years, until it is ready to make a cash contribution to the trust to finance the purchase of the shares from the vendor shareholder. The shares it acquires can then be retained within the trust.
Tax advantages of EOT
Shares in the company are held in a special type of discretionary trust and are not owned directly by the employees. The EOT receives preferential tax treatment provided that all employees are eligible to receive some benefits from the trust entity.
The tax benefits of an EOT are:
- No capital gains tax for the controlling shareholder to pay on sale of their shares to the EOT. Compare this with the traditional route of claiming entrepreneurs’ relief which reduces the capital gains tax rate from 20% to 10% on the first £10m of gains from a share sale;
No income tax or NICs payable on annual bonuses issued by the trust to employees. A maximum value of up to £3,600 can be paid to all trust beneficiaries (employees) from 1st October 2014, provided they have completed at least 12 months’ service.
Establishing an EOT could be a useful strategy for companies looking to offer a form of share ownership to a wide range of employees. For entrepreneurs who wish to retire but allow the employees who helped them build their business achieve indirect ownership of the company, a sale to an EOT is a way of achieving this. It also avoids burdening the employees with personal debt to fund the buyout. The stresses to the vendor shareholder of a sale to a third party purchaser are also avoided, and a tax-free sale is achieved providing there is a transfer of ownership and control to an EOT. It enables the company to remain independent and provided the vendor shareholder can be patient about realising the financial returns over a longer period of time, it could be an ideal strategy.
