The Budget: A step towards future proofing the Employee Ownership Trust?

The lead up to 30 October 2024 was rife with speculation about the changes that would be proposed by Labour in their first budget in 14 years. Various rumours were spreading around impending Capital Gains Tax (‘CGT’) increases and changes to the Inheritance Tax and Pensions regimes. Naturally experts around the country were anticipating how these would affect individuals and businesses in the UK. Rumours around changes to the Employee Ownership Trust (‘EOT’) legislation were eerily scarce and we took the view that no news is good news. With EOTs originally being a Liberal Democrat idea endorsed by the Conservatives in the coalition government as well as by Labour, it should, (in theory) be a politically neutral idea that could continue on long into the future. Many experts were singing from the same hymn sheet and felt that if the Government were to take into account the results of the EOT consultation in September 2023, where EOT experts across the UK gave their recommendations on how EOTs could be strengthened, then the EOT could certainly stand the test of time.

The budget was delivered and it lived up to its billing

With the delivery of the Autumn budget, speculation has now ended. Despite the raft of changes to the aforementioned regimes, from an EOT perspective it is positive news and positive change for EOTs.

There were changes to Inheritance Tax (‘IHT’) reliefs such as Business Property Relief and Agricultural Property Relief and with pensions now being brought in to the scope of IHT, the overall outlook is bleak.

The CGT regime also saw adjustments with headline rates increasing and Business Asset Disposal Relief (‘BADR’) seeing tapered increases in the coming years. Basic rate CGT has increased from 10% to 18%, with higher rate CGT increasing from 20% to 24%. BADR was one of the key reliefs afforded to risk-takers, originally providing them a reduced 10% rate of CGT on gains of up to £10m. This was then reduced to £1m at 10%. Whilst the £1m BADR lifetime limit has been retained, the reduced rate from which sellers would benefit will be increased to 14% from 6^th April 2025 and then again up to 18% from 6 April 2026.

Let’s face it, these increases penalise entrepreneurs, business owners, equity holders and discourage such individuals from exiting. In the midst of all the tax increases, EOTs can be the light at the end of the tunnel, with EOT relief providing a fully tax-free exit no matter the CGT rate. EOTs really do offer a no gain, no pain solution.

Key Adjustments to EOTs

That said, there were adjustments to the EOT legislation, but these changes come as no surprise to us as experts in this field. The Government listened to points raised in the consultation and just over a year later have implemented changes to EOTs that are welcomed by the profession. The additional legislation bolsters the anti-abuse provisions in specific areas, many of which were loosely covered in some of the existing legislation. Other areas were not mentioned in the existing legislation, but were already foreseen and practised by any prudent and diligent EOT advisor. Having been well abreast of such matters, our experts have been structuring EOT deals in a ‘best practice’ method which has been well within the bounds of the proposed changes for years.

Here is a brief summary of the key changes:

• EOT relief clawback period extended – Previously, vendors would be on the hook for a clawback of the CGT relief if there was a disqualifying event in the tax year of the sale and the following tax year. This has now been extended such that vendors will be liable the tax year of sale and the following four tax years.
• No more offshore trustees - Before the budget, it was possible to have an offshore trustee of the EOT. This enabled the EOT to sell companies without suffering a charge to CGT. However, trustees must now be UK resident to meet CGT relief requirements. This means that EOT businesses can no longer appoint an offshore trustee to avoid CGT in a sale of the business in the future. This is a strengthening of the anti-abuse and anti-avoidance provisions by HMRC. We have always advocated for and implemented onshore trustees for our clients.
• Former vendors cannot control the EOT – Individuals who currently own, or have previously owned 5% of the share capital of the company must now be outnumbered by other trustees or by other trustee directors on the board of the trustee company. This provision ensures that previous vendors cannot have majority control of the EOT. We have always advised that this should be the case in best practice.
• Trustee(s) must take reasonable steps to ensure consideration paid does not exceed market value – With no previous requirement to do so, this is a positive step to ensure EOTs are not overpaying to acquire businesses. We have historically required an independent third party valuation to ensure EOTs do not overpay for their acquisitions. This is also to ensure the valuation would be robust in the event of any dispute. Disputes are unlikely unless the value is grossly overstated due to a valuation error. We have not seen dispute of this nature in our experience.
• Company directors can be excluded from tax free bonus payments – It was not previously possible (without great difficulty) for a bonus award to be made without breaching the participation and equality requirements, which require every employee, regardless of their position, to receive a tax-free bonus payment on the same terms. Excluding directors is still at the discretion of the trading company board, but could benefit EOT businesses with smaller employee numbers by ensuring the tax-free bonus pot is allocated wholly to the non-director employee base, which employees will welcome.
• No more grey area on the treatment of a contribution to an EOT – There was always a grey area with regard to the treatment of contributions by trading companies to EOTs to settle vendor debt in terms of both the tax treatment and classification of the contribution within company law. HMRC did acknowledge the point through an extra-statutory concession previously, but the newly inserted section 401ZA Income Tax (Trading and Other Income) Act 2005 makes it clear that such contributions are not taxable, providing the conditions are met. This will save many advisers from submitting non-statutory clearances on this point going forward.
• Further reporting requirements - Information on sale proceeds and number of employees must now be included in CGT relief claims with self-assessment tax returns from 6 April 2025 onwards. This is a prudent adjustment from HMRC and is in line with the advice that many clients have received from their accountants and/or tax advisers.

All in all, the changes resulting from the budget are positive for EOTs. Increased anti-abuse provisions and the aforementioned adjustments are in line with the recommendations made by experts over the years, bringing EOTs into line with the intentions of Parliament. Some may go as far as saying EOTs have been ‘future proofed’, at least for the short to medium term anyway.

Increases in CGT, whilst not favourable, increase the value that an EOT can provide to business owners looking for an incentivised exit, ensuring they do not have to suffer increased CGT liabilities and the undue stress of negotiation associated with other succession alternatives. EOTs have come through the budget materially unscathed and will continue to offer what is, in our opinion, the standout succession solution for employees, businesses and owners across the UK.