Employee Ownership Trusts: Looking to the future

Welcome to the first article in our new series, Employee Ownership Trusts: Looking to the Future.  In this series we will be exploring some of the opportunities and challenges facing businesses after the transition to employee ownership.

In our first article, the TLT Employee Ownership team discusses the vendors’ capital gains tax relief on the sale of a company to an employee ownership trust, the risk of losing the relief post-transition and the impact of the Autumn Budget 2024 measures.

What is an employee ownership trust?

An employee ownership trust (EOT) is a special type of discretionary trust which is established by a trading company (or the parent company of a trading group), for the purpose of acquiring a controlling interest in that company. The trustee of the EOT holds the shares on the terms of the trust for the employees of the company, who are the beneficiaries of the trust.

There are a number of statutory conditions which a trust has to satisfy in order to qualify as an EOT including:

• a requirement that the company whose shares are acquired is either a trading company or the parent company of a trading group;

• a requirement that the trust acquires a “controlling interest” in the company; and

• a requirement that the assets of the trust are used only for the benefit of the company’s employees and that the employees benefit on the same terms.

What are the capital gains tax implications for the vendors of a sale to an EOT?

A full relief from capital gains tax is available to the vendors (other than any which are companies) when they sell a controlling interest in the trading company to the EOT. However, that relief can be wholly lost, if certain “disqualifying events” (which include a breach of any of the requirements set out above), take place within a certain period following the sale to the EOT. The occurrence of a “disqualifying event” may therefore give rise to an unexpected, and unwelcome, capital gains tax liability for the vendors.

Prior to 30 October 2024, if a disqualifying event occurred before the end of the tax year following the tax year in which the sale of shares to the EOT took place (commonly referred to as the “vendor clawback period”), then the vendors were prohibited from making a claim for capital gains tax relief and, if such a claim had already been made in relation to the sale, the claim was revoked and any capital gains tax arising from the sale calculated as if the claim had never been made.

In practice, this meant that a vendor could be at risk of the capital gains tax relief being unavailable for a period of up to two years after the sale, depending on when, in the tax year, the sale to the EOT took place.  By way of example, an individual vendor claiming capital gains tax relief on the sale of a controlling interest in a trading company to an EOT on 7 April 2022 would be subject to 100% clawback of that relief if a disqualifying event occurred on or before 5 April 2024.

How is the relief changing?

As a result of the measures announced at the Autumn Budget held on 30 October 2024, the vendor clawback period has been extended so that for disposals on or after 30 October 2024, the vendor clawback period will end on the expiry of the fourth tax year following the tax year in which the sale to the EOT occurs. 

This extension is a substantive change to the capital gains tax relief and was an unexpected addition to a number of measures affecting EOTs announced at the Autumn Budget.  The previous Conservative government had launched a consultation on proposals to reform the tax treatment of EOTs in July 2023, however, extension of the vendor clawback period was not one of the proposals included in that consultation.

The change means that a vendor who sells their shares to an EOT early in a tax year risks losing the capital gains tax relief in full, for a period of up to 5 years following the sale.  By way of example, an individual vendor claiming capital gains tax relief on the sale of a controlling interest in a trading company to an EOT on 7 April 2025 would be subject to 100% clawback of that relief if a disqualifying event occurred on or before 5 April 2030.

What steps can a vendor take to prevent clawback of the relief?

There are a number of practical steps that a vendor can consider taking to mitigate the impact of the extension to the vendor clawback period. These include:

• Trustee board appointment: a vendor may wish to be appointed as a director of the EOT trustee company enabling the vendor to have some influence over the future of the EOT structure, including any potential sale of the trading company out of the EOT.

  However, such an appointment may be restricted by the new trustee independence requirement, which applies to sales to an EOT on or after 30 October 2024 and requires that less than 50% of the trustee directors are former owners (or persons connected with them).  The requirement is aimed at preventing the vendors from retaining control of the trading company following the sale to the EOT.  A breach of that requirement will (other than in very limited circumstances), give rise to an immediate disqualifying event.  

• Planning the timing of the sale: a sale to an EOT in the early part of a tax year will increase the length of time during which the vendor is at risk of the capital gains tax relief being revoked. Therefore, vendors should take this into account in planning when a sale to the EOT should complete to avoid inadvertently triggering a longer clawback period.

• Ring-fencing the tax at risk: the vendor may choose to set aside a proportion of the upfront cash consideration received on the sale to the EOT equal to the capital gains tax liability that would arise if the relief were to be revoked. This initial planning would avoid a dry tax charge arising for the vendor a number of years after the sale taking place.

• Communicating the purpose of the sale: For many vendors, a sale to an EOT is preferable to a conventional trade sale, because it offers the vendors a way to exit their business whilst preserving the ethos, culture and values of their business and rewarding those who have worked to make it a success. For those vendors, the transition to an EOT structure is often embarked on because the vendors believe that it will secure the longer-term future of the company. Documenting the intention behind the sale to the EOT in the governance documents at the outset can provide useful guidance for the EOT trustee in the future exercise of its decision-making powers.

How can we help?

TLT has been a leading firm active in the employee ownership sector for a number of years.  Our specialist, and experienced, employee ownership lawyers have a diverse range of clients in England, Wales, Northern Ireland and Scotland. 

We provide insightful strategic direction to employee-owned businesses at every stage of their journey and have led a number of the most high profile employee ownership transactions within the UK.

If you are interested in discussing how a move to employee ownership could shape your business or how we can support you achieve success following the transition to employee ownership, get in touch with our employee ownership specialists below.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at February 2025. Specific advice should be sought for specific cases. For more information see our terms and conditions.