Unintended consequences to EOT legislation?

Now that the dust has settled following the raft of Autumn Budget tax announcements, TLT’s Nimarta Cheema and William Ngan have been considering the potentially unintended consequences of the changes to the EOT legislation.

As we explained in our Insight earlier this month, the government has announced the introduction of a package of reforms to the taxation of Employee Ownership Trusts (EOTs), the majority of which will take effect in relation to disposals to an EOT on or after 30 October 2024 (subject to enactment of the Finance Bill 2024-25).

Whilst we are broadly supportive of the EOT changes, there are certainly some hidden traps within the draft legislation which shouldn’t be overlooked when structuring the transition to an EOT model.

• Trustee independence requirement: a breach of this requirement (which prevents the former owners from retaining control of the company post-sale to the EOT) will give rise to an immediate disqualifying event, unless the breach is caused by the death of an EOT trustee in which case a 6-month grace period applies. Unlike the existing limited participation requirement, there is no grace period if the requirement is breached for any other reason. It is not uncommon for the board of directors of an EOT trust company to be comprised of only three trustee directors - a seller, an independent trustee and an employee – meaning that the resignation of either the independent trustee or the employee could trigger an immediate disqualifying event and disadvantageous tax consequences for either the vendor or the EOT. We are unsure if this is the intention of the new requirement and we consider that adding a grace period would be reasonable.

• Market value requirement: the draft legislation requires the trustees of an EOT to take “all reasonable steps” to ensure that consideration paid to acquire the shares does not exceed market value. EOT trustees will be hoping for clarificatory guidance from HMRC on the scope of this requirement as it is currently unclear what practical steps EOT trustees will have to take to satisfy that requirement. For example, will the EOT trustees be required to obtain their own independent advice relating to valuation and affordability?

• Clawback period: the extension of the vendor clawback period from 1 to 4 years is a significant, and unexpected, change - it was not one of the proposals set out in the July 2023 consultation on the taxation of EOTs. As a result of the change, 100% of the tax relief on the sale to the EOT can be recovered from the vendors if a disqualifying event occurs before the end of the fourth tax year following the end of the tax year of disposal. For vendors who sell shortly after the start of a new tax year, there will be almost a five-year period during which the full tax relief might be withdrawn – no tapering of the withdrawal of tax relief is provided for in the draft legislation. We suggest that the government adds tapering relief for vendors.

• Contributions to the EOT: the new relief from income tax distribution treatment for contributions paid by the EOT-owned company to the trustees of the EOT is limited to a specified list of “acquisition costs” incurred by the EOT trustees. These include the sale consideration, deferred consideration and stamp duty costs but notably do not include professional fees incurred by the EOT trustees in connection with the sale. Is that deliberate or an oversight?
  We will explore the above topics in more detail over the coming weeks.

Nimarta and William are looking forward to attending the Employee Ownership Association conference 2024 on Tuesday 26 and Wednesday 27 November. If you are attending that event, they would welcome the opportunity to hear your views on these changes – you can find them at TLT’s exhibition stand. Alternatively, you can share your views with them using the contact details below.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at November 2024. Specific advice should be sought for specific cases. For more information see our terms & conditions.