Professional firms and Employee Ownership Trusts

6 November 2023 / Insight posted in Article

Employee Ownership Trusts (EOTs) were introduced by the government in 2014 in order to encourage indirect employee ownership of trading businesses. Since their introduction, increasing numbers of professional firms have been sold to EOTs, resulting in commercial benefits for the firm, and tax benefits both for the former owners and for the employees.

The tax benefits of EOTs are only available where the EOT acquires and holds shares in a trading company and so, where a firm is carried on through a partnership or LLP, that firm would need to be incorporated. The strength of the partnership ethos in some professions meant that professional firms were, on-the-whole, relatively slow to start considering EOTs.

Over more recent years, however, professional firms of various kinds have started to embrace EOT-ownership in greater numbers, increasingly seeing this as a means of dealing – in a tax efficient way – with succession challenges for owners looking to retire, whilst also engaging and inspiring employees for the long term. The main proviso to this, is that registered auditors must be owned and controlled by audit qualified individuals. So, firms with an audit business would need to hive this off if they were to use an EOT structure.

Typically, in selling to an EOT, shareholders will sell their shares at market value, meaning they should ultimately receive broadly the same as they would through a trade sale or management buy-out. Some or all of the consideration will typically be deferred and then funded from future business profits over future years, although it may be possible to use debt to advance the payment of the consideration. When certain qualifying conditions are met, the sale of shares to an EOT will be treated as taking place on a nil gain/nil loss basis for tax purposes, meaning it will be free from capital gains tax.

The key conditions for this capital gains tax treatment to be available can be summarised as follows:

  • The company whose shares are sold must be a trading company or the holding company of a trading group
  • The EOT must hold its assets solely for the benefit of eligible employees (essentially all employees except those who have held more than 5% of the company
  • The EOT must acquire and retain at least a 50% controlling interest in the company
  •  The number of continuing 5%+ shareholders (and any persons connected with them) who are directors or employees cannot exceed 40% of the group’s total number of employees.

The other key tax benefit of EOTs is that companies owned by EOTs will typically be able to pay bonuses to eligible employees of up to £3,600 per year without income tax arising. All employees (except possibly those subject to disciplinary proceedings or those without a qualifying employment period) must be eligible to participate in these bonuses, although distinctions in the actual amounts paid can be made on the basis of hours worked, length of service, or remuneration. Therefore, not only do employees of these businesses know that they are the ultimate beneficial owners, but they can also receive a financial benefit each year.

If you would like to consider the possibility of selling your firm to an EOT please speak to our professional firms experts.

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