What is an Employee Ownership Trust?

What is an Employee Ownership Trust?

An Employee Ownership Trust (EOT) is a special type of discretionary trust which is established by a company, 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 - this represents indirect employee ownership. The trustee must act in the best interests of the employees.

What conditions does a trust have to satisfy to qualify as an EOT?

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

These include:

• 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.

Why should founders consider a sale to an EOT?

A sale to an EOT can offer the founders 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. In particular, a sale to an EOT can be a practical solution for family-owned or owner managed businesses considering long-term succession planning.

Founders selling their business to an EOT can benefit from an exemption from capital gains tax on the sale of their shares if certain conditions are satisfied at the time of the sale and for a specified number of years following the sale.

Do the founders have to sell all of their shares to the EOT to benefit from the capital gains tax exemption?

No. The EOT model is flexible so that as long as the EOT acquires a “controlling interest” in the company, it is possible for the founders to retain a shareholding in the company. In order to acquire a “controlling interest”, the EOT must acquire, broadly, more than 50% of the ordinary share capital and voting rights in the company.

Founders should consider carefully what proportion of their shareholding they wish to sell to the EOT and note that if they don’t sell all of their shares to the trust in one transaction, they may not be eligible for the capital gains tax relief on a subsequent sale of the balance of their shares.

What is the role of the trustee in running the business following a sale to an EOT?

Following a sale to an EOT, the day-to-day operation of the trading company continues to be carried out by the board of directors of the trading company.

The role of the trustee is to oversee the board of directors and the overall business strategy.

What are the benefits for the employees of their employer becoming employee-owned?

The employees will be the beneficiaries of the EOT which means that, subject to certain conditions, they are eligible to receive an annual bonus of up to £3,600 per employee which can be paid to them free of income tax (although National Insurance contributions will apply).

As the EOT is established for the benefit of the employees, it is usual for the employees to play an important role in determining how the company is run following the transition. Often the employees will elect one (or more) employees to act as trustee of the EOT or, if the trustee is a company, to sit as a director on the board of directors of the trustee company. In addition, the business may establish an employee council so that the views of the employees can be taken into account by the board of directors of the company and the trustee in their decision-making.

In contrast to a third-party sale, in an employee ownership model the founders will typically continue to work in the employee-owned business (in some capacity) following the transition at least for a period of time, providing stability and reassurance to the employees.

Is it possible to incentivise employees after a sale to an EOT?

Yes it is. In addition to the income tax free bonus which the employee-owned company can pay to eligible employees each year, employee share plans can play a crucial role in the retention and motivation of employees following the transition.

EMI options and CSOP options are both commonly adopted forms of HMRC tax-advantaged employee share incentive. These incentives work on the basis that an employee is granted a right to buy shares in their employer in the future at a price fixed at the date of grant. The price is usually the market value of the underlying shares at the date of grant. The employee may exercise the right to buy the shares at set vesting dates or when meeting set performance conditions, provided they remain in employment. Options are simpler to administer than plans that provide for the outright acquisition of shares and are risk free for employees since they don’t have to exercise their right to buy the shares.

There is a limit on the market value (at the date of grant) of the shares over which EMI options and CSOP options can be granted to an employee of £250,000 and £60,000 respectively and there are certain statutory conditions which must be satisfied in order for a company to qualify to grant these types of options.

Alternatively, the company may wish to consider establishing a growth share plan, which is a popular way to incentivise employees if the company is unable to grant EMI or CSOP options. Under a growth share plan employees acquire a new class of shares in the company and the new class is only entitled to participate in any future increase in the value of the business. The entitlement to future value only means that at the outset the shares are worth very little, meaning that the employee typically only pays a small amount to acquire the shares. Although growth shares are not an HMRC tax-advantaged form of share plan, they provide a similar tax outcome to EMI and CSOP options.

Care needs to be taken when implementing any share plan for an employee-owned company to ensure that the trust continues to satisfy all the conditions necessary for it to qualify as an EOT. However, with careful planning, share incentives can be successfully implemented by an employee-owned company.

Read our insight here for further detail.

How will the measures announced at the Autumn Budget 2024 affect EOTs?

A number of changes to the rules relating to EOTs were announced at the Autumn Budget 2024. However, there are only two changes which will affect EOTs which were established before 30 October 2024. Those changes are a relaxation of the rules relating to the payment to employees of annual tax-free bonuses and a minor change to the information that a selling shareholder must provide to HMRC to make a claim for capital gains tax relief.

Several new conditions will have to be satisfied for a selling shareholder to qualify for capital gains tax relief where the sale to the EOT occurs on or after 30 October 2024. These include:

• a trustee independence requirement preventing selling shareholders (or persons connected with them) from retaining control of the company post-sale to the EOT;
• a requirement that the trustees of the EOT be UK resident; and
• a requirement that the trustees take all reasonable steps to make sure that they don’t pay more than market value for the shares in the company.

In addition, the period within which the capital gains tax relief can be recovered from the selling shareholders if the conditions applying to the relief are breached post-sale will be extended to the fourth tax year following the end of the tax year in which the disposal took place.

We explore the changes in further detail in our insights here and here.

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 EOTs, 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 March 2025. Specific advice should be sought for specific cases. For more information see our terms & conditions.