Tax efficient exit strategies and staff incentivisation have become hot topics among leadership teams in the broking community since the increases in Capital Gains Tax (CGT) and Employer National Insurance announced in the Budget last autumn. Corporate Tax Partner, Catherine Heyes, examines how broker owners can use Employee Ownership Trusts (EOTs) to respond to these developments.
EOTs have been around since 2014, but tend not to have a particularly high profile. They can provide an effective and efficient exit route for broker owners, whilst also offering longer term incentivisation and equity ownership for employees.
What are the tax benefits?
Selling their interest to an EOT is a mechanism that broker owners could consider if they want their employees to take over the running of the business, or when a sale to a third party is not an option. In addition, there is also a tax advantage to using this route.
If operated correctly, an EOT enables shareholders to dispose of a controlling interest (in other words, more than 50% of the ordinary share capital of the company) of their broker company at market value, to the EOT, without incurring CGT. Owners can make a full disposal if they wish, just like a third-party exit; however, only a minimum controlling interest needs to be sold to access the tax benefit with the EOT.
This is particularly important at the moment because the benefits that brokers may have previously received from Business Asset Disposal Relief are being eroded, following the imposition of lower thresholds in last year’s Budget.
The other tax benefits of EOTs are that there is an Inheritance Tax exemption in respect of a transfer of value to the EOT; usually a transfer of value into a trust constitutes a Chargeable Lifetime Transfer. There is also an income tax exemption of up to £3,600 on qualifying cash bonus payments made to qualifying employees; these payments do, however, attract National Insurance (NI).
It is important to note that the transfer of the business to the EOT means that the company is then controlled by the employees of the company (although, since the EOT is a trust, the employees have indirect share ownership). The employee/director shareholders can, however, remain in the company post-disposal and receive market-rate remuneration packages.
If it wishes, the EOT can, in the future, decide to dispose of its shares in the company. For an onshore trust, this will result in a liability to CGT at that point in time. The proceeds of the sale will then be distributed to the employees as the beneficiaries, and subject to PAYE/NI.
Finally, don’t forget that you can make an EOT even more advantageous by wrapping it up within an approved incentivisation scheme, such as an Enterprise Management Incentive (EMI) or a Company Share Option Plan (CSOP). We have written about these options in the past, should you wish to find out more.
What are the conditions?
As you would anticipate, there are a number of qualifying conditions that have to be met in order to unlock the tax benefits of an EOT. Moreover, the government introduced additional measures last autumn to further tighten the eligibility criteria. Some of these include:
- EOT trustees must take ‘reasonable steps’ to ensure the purchase price for the company’s shares does not exceed their market value
- Offshore trustees will no longer be permitted going forward; the EOT has to be UK resident
- There will be an increase to the disqualifying period. This means that should any breach of the qualifying conditions occur within the first four years post disposal, CGT relief for selling shareholders will be withdrawn (and CGT will become due on the gain that occurred on the original disposal).
Don’t forget about your employees!
Whilst the CGT benefit to exiting shareholders is often a key driver of introducing an EOT, it is important to remember that employee incentivisation and ownership is another key principle of an EOT. As well as giving employees ‘skin in the game’, selling to the EOT as opposed to a third party may help maintain company culture and ethos, for example.
You should ensure that you consult the team throughout the EOT process, so that they are fully engaged, and understand their new responsibilities – after all, they will have a key role in running the business going forward! In particular, it is important that employees understand that they need to work together to drive the future success of the business, including focusing on managerial and financial matters that they may not have had to worry about before.
If you decide not to make a full exit, you would also need to consider how you will work alongside the EOT, just as you would with the external investor in a third party scenario: remember that the trustee of the EOT will have voting control at shareholder meetings.
EOTs merit further consideration if you are considering selling your broking business. If you would like to understand EOTs in more detail or have wider equity incentivisation requirements, please contact Catherine Heyes.
This article was originally published in Insurance Age. For more information, please contact Catherine Heyes.
