How is an Employee Ownership Trust taxed in the UK?

An Employee Ownership Trust, or EOT, is a trust set up to allow a company to be owned by its employees. This means the employees are the ultimate beneficiaries of a business and can benefit directly from its continued growth and success.

One of the most significant benefits of an EOT is for the exiting shareholders, who will not have to pay Capital Gains Tax (CGT) when selling their shares, subject to meeting the qualifying criteria. The sale of business shares is ordinarily subject to CGT at a rate varying from 10% to 24%, depending on the shareholder’s personal circumstances.

But what about other taxes? In this blog, we will briefly outline the tax treatment of an EOT-owned business.

Taxes paid by EOT-owned businesses

For tax purposes, a company owned by an Employee Ownership Trust is mostly treated like any other trading limited company. The company will continue to be subject to most standard business taxes in the UK:

• Corporation Tax: Paid on the company’s profits at a main rate of 25%, with a small profits rate of 19% available to some companies.
• VAT: If an EOT-owned company is VAT-registered, it will need to charge VAT on taxable sales and reclaim VAT on its purchases like other VAT-registered businesses.
• Business Rates: EOT-owned businesses will have the same property taxes levied on commercial properties.
• National Insurance Contributions: EOT-owned companies are required to pay Employer National Insurance Contributions on employee wages and salaries.
• Other taxes: Like other companies, EOT-owned businesses will be subject to several additional taxes, depending on the activities undertaken by the business. These include, but are not limited to:
  • Landfill tax
  • Alcohol duty
  • Insurance premium tax
  • Fuel duty
  • Stamp Duty Land Tax
  • Air Passenger Duty
    
    

How are EOTs taxed differently?

While the main taxes paid by an EOT-owned company are the same as those for a regular limited company, there are three significant areas of difference.

Capital Gains Tax exemption

When the qualifying conditions are met, the exiting shareholders who sells a stake in their business to an EOT will be effectively be exempt from Capital Gains Tax. This is a major benefit for the existing owners and a large driver of interest in EOTs as a whole (though the fantastic tax benefits this shouldn’t be the only reason to pursue an EOT!)

Important: There is a vendor clawback period, recently extended to four years, during which HMRC can recover tax from former owners if the EOT rules are broken post-sale.

Income Tax-Free bonuses for staff

Qualifying EOTs can pay employees annual bonuses of up to £3,600 a year income tax-free (although the bonus is subject to National Insurance Contributions). The government has recently relaxed the rules around tax-free bonuses, allowing them to be given to employees with directors excluded.

Inheritance Tax (IHT) benefits

There is no charge for Inheritance Tax on the transfer of shares to an Employee Ownership Trust (EOT); furthermore, the EOT itself is exempt from the Inheritance Tax applicable to relevant property regimes.

Why might the tax position of an EOT be confusing?

The tax treatment of Employee Ownership Trusts (EOTs) in the UK can be confusing for several reasons.

Changing legislation

Firstly, the legislation surrounding EOTs is still relatively new and may not be widely understood. It is also subject to change, with a swathe of changes to EOT rules in 2024.

Specific and unique tax benefits

There are also some specific and very generous tax benefits associated with EOTs, which impact both the employees and the business owners. However, there are strict and intricate requirements to qualify for these benefits.

A complex transaction and implementation

Additionally, many businesses may lack clear guidance on implementing EOTs while ensuring proper compliance with the relevant legislation. This complexity can lead to misunderstandings and potential pitfalls when establishing an EOT. Qualified advice is essential when embarking on an EOT transaction.