What is an Employee Ownership Trust (EOT)?

An EOT is a trust that holds shares on behalf of employees. When a business owner sells a controlling interest (51%+) to an EOT, the gain is exempt from CGT (0% rate). Employees benefit through tax-free bonuses of up to £3,600 per year. An Employee Ownership Trust (EOT) is a trust structure that allows a business owner to transition their company to employee ownership. How it works: (1) The business owner sells a controlling interest (51%+) in the company's shares to the EOT. (2) The EOT holds the shares on behalf of all employees — employees do not directly own the shares, but benefit through the trust. (3) The EOT is funded by the company's profits (the company pays dividends to the EOT or makes contributions). (4) The EOT can distribute tax-free bonuses to employees (up to £3,600 per year per employee). (5) The EOT is governed by independent trustees who act in the best interests of the employees. The key tax advantage: the selling shareholder's gain on the sale is exempt from CGT (0% rate, compared to 10% BADR or 24% standard CGT). This can save the owner hundreds of thousands or millions of pounds. The EOT must meet several conditions to qualify for the tax reliefs, including holding a controlling interest, being for the benefit of all employees, and being UK-resident. Relevant legislation: TCGA 1992, Section 236B (CGT relief for EOT sales); ITEPA 2003, Sections 499-501 (tax-free bonuses); Finance Act 2014 (introduction of EOTs). Example: A business owner sells 100% of their company (worth £5 million, cost £500,000) to an EOT. The gain is £4.5 million. Under the EOT relief, the CGT is £0 (0% rate). Without the EOT (using BADR), the CGT would be £450,000 (10% of £4.5 million). The EOT saves the owner £450,000 in CGT. The EOT also pays tax-free bonuses of £3,600 per employee per year. Common mistake: Assuming that the EOT gives employees direct share ownership. Employees do not directly own the shares — the EOT holds the shares on their behalf. Employees benefit through the trust and through tax-free bonuses.

How does the EOT CGT exemption work?

If a business owner sells a controlling interest (51%+) to an EOT at market value, the gain on the sale is exempt from CGT (0% rate). This compares to 10% BADR or 24% standard CGT. The conditions include: controlling interest, all-employee benefit, market value sale, and UK-resident EOT. The EOT CGT exemption is one of the most generous tax reliefs available to business owners. How it works: (1) Sale to EOT — the business owner sells a controlling interest (51%+) in the company's shares to an EOT. (2) Market value — the sale must be at market value (the EOT cannot overpay for the shares, as this would be a tax advantage for the owner). (3) CGT exemption — the gain on the sale (market value minus cost) is exempt from CGT. The CGT rate is 0% (compared to 10% BADR or 24% standard rate). (4) Conditions — the following conditions must be met for the exemption: (a) The EOT holds a controlling interest (51%+) of the ordinary share capital after the sale. (b) The EOT is for the benefit of all employees (not just selected employees). (c) The EOT is UK-resident. (d) The EOT is independent (the trustees act in the best interests of the employees, not the former owner). (e) The sale is not part of a tax avoidance arrangement. (5) Part-sales — if the owner sells less than 100% (but at least 51%), the exemption applies to the portion sold. (6) Funding — the EOT typically funds the purchase through the company's future profits (the company pays dividends to the EOT, which uses the funds to pay the seller). The CGT exemption can save the owner a significant amount — on a £5 million gain, the saving is £500,000 (compared to BADR) or £1.2 million (compared to standard CGT). Relevant legislation: TCGA 1992, Section 236B (CGT exemption for EOT sales); TCGA 1992, Section 236H (conditions for the exemption). Example: A business owner sells 60% of their company to an EOT. The company is worth £5 million, so 60% = £3 million. The owner's cost for 60% is £300,000. The gain is £2.7 million. The CGT exemption applies (the EOT holds 60%, which is a controlling interest). CGT: £0. If the owner had sold 40% (not a controlling interest), the exemption would not apply, and the gain would be subject to BADR (10%) = £270,000. Common mistake: Selling less than 51% to the EOT and assuming the CGT exemption applies. The EOT must hold a controlling interest (51%+) for the exemption to apply. Part-sales below 51% do not qualify.

How do EOT employee bonuses work?

EOTs can pay tax-free bonuses to employees of up to £3,600 per year per employee. The bonus is free of income tax (but subject to employer NIC). All employees must be eligible for the bonus (the company cannot exclude employees, other than those with less than 12 months of service). EOTs can pay tax-free bonuses to employees, which is one of the key benefits of employee ownership. How the bonus works: (1) Amount — up to £3,600 per employee per year. The bonus is free of income tax (but subject to employer NIC at 13.8% on the amount above £8,840 per year). (2) All-employee — the bonus must be offered to all employees who meet the eligibility requirements. The company can exclude employees with less than 12 months of service, but cannot exclude employees based on role, seniority, or hours worked. (3) Pro-rata — the bonus can be paid on a pro-rata basis (e.g., part-time employees receive a proportionate amount). (4) Source — the bonus must be paid from the company's profits (not from the EOT's capital). (5) Distribution — the bonus is typically paid by the company (as directed by the EOT trustees), not by the EOT itself. (6) Tax — the bonus is free of income tax for the employee. The company can deduct the bonus as a trading expense (reducing corporation tax). The employer NIC is due on the bonus. The tax-free bonus is a powerful incentive for employees and reinforces the benefits of employee ownership. It also serves as a recruitment and retention tool for the company. Relevant legislation: ITEPA 2003, Sections 499-501 (EOT employee bonuses); ITEPA 2003, Section 499 (conditions for tax-free bonus). Example: A company with 50 employees and an EOT pays a tax-free bonus of £3,600 to each employee (total £180,000). Each employee receives £3,600 tax-free. The company deducts £180,000 as a trading expense (saving corporation tax at 25% = £45,000). The employer NIC is £0 (if each employee's total earnings are below £8,840 per year) or 13.8% of the bonus above £8,840. Common mistake: Paying the bonus only to senior employees. The bonus must be offered to all eligible employees (the company can only exclude employees with less than 12 months of service). Paying selectively can result in the loss of the tax-free status.

How is an EOT funded?

The EOT is typically funded by the company's future profits. The company pays dividends to the EOT (which holds the shares) or makes contributions. The EOT uses these funds to pay the selling shareholder and to fund employee bonuses. The EOT is typically funded by the company's future profits, as the EOT itself does not have its own funds at the time of the sale. How the funding works: (1) Purchase price — the selling shareholder agrees a purchase price with the EOT (at market value). The EOT does not pay the full amount upfront — it typically pays through a combination of: (a) Initial payment — a portion of the price paid at completion (from the company's cash or a loan). (b) Deferred payments — the balance paid over several years from the company's future profits. (2) Dividend payments — after the sale, the EOT holds the shares and receives dividends from the company. The company pays dividends from its after-tax profits. The EOT uses the dividends to pay the deferred purchase price and to fund employee bonuses. (3) Company contributions — the company can also make direct contributions to the EOT (which are tax-deductible for the company). (4) Loan — in some cases, the company or the EOT takes out a loan to fund the initial payment, which is repaid from future profits. (5) Vendor loan — the selling shareholder may provide a vendor loan (lending the purchase price to the EOT, which repays from future profits). The funding structure means that the selling shareholder does not receive the full purchase price upfront — they receive it over several years as the company generates profits. This aligns the interests of the seller, the EOT, and the employees, as all benefit from the company's future success. Specialist advice is essential to structure the funding correctly and ensure the EOT can meet its payment obligations. Relevant legislation: TCGA 1992, Section 236B (EOT funding); Corporation Tax Act 2010 (dividend payments and company contributions); Finance Act 2014 (EOT legislation). Example: A business owner sells their company for £5 million to an EOT. The EOT pays £1 million at completion (from the company's cash) and agrees to pay the remaining £4 million over 5 years from the company's future profits. The company pays £800,000 per year in dividends to the EOT, which uses the funds to pay the seller. The EOT also pays tax-free bonuses of £3,600 per employee per year from the dividends. Common mistake: Not assessing the company's ability to generate sufficient profits to fund the deferred payments. If the company cannot generate enough profits, the EOT may default on the payments to the seller, creating financial and legal difficulties.

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Employee Ownership Trusts (EOTs)

EOTs allow business owners to sell their company to employees with significant tax reliefs. Understand the CGT exemption, employee bonuses, and how to transition to employee ownership.

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Employee Ownership Trusts (EOTs) are a powerful structure for transitioning a business to employee ownership. When a business owner sells a controlling interest in their company to an EOT, the gain on the sale can be exempt from CGT — a significant incentive for owners considering succession planning. EOTs also allow tax-free bonus payments to employees (up to £3,600 per year per employee). Understanding how EOTs work and their tax advantages is essential for business owners considering employee ownership as an exit strategy.

How EOTs Work

An EOT is a trust that holds shares on behalf of employees. The process: (1) The business owner sells a controlling interest (51%+) in the company to the EOT. (2) The EOT holds the shares for the benefit of all employees. (3) The EOT is funded by the company's profits (through dividend payments or contributions). (4) Employees benefit through tax-free bonuses (up to £3,600 per year) and indirect ownership of the company. The EOT must meet specific conditions to qualify for the tax reliefs.

CGT Relief for Selling Shareholders

The most significant tax advantage of an EOT is the CGT exemption for the selling shareholder. If the owner sells a controlling interest (51%+) to an EOT, the gain on the sale is exempt from CGT (0% rate, compared to 10% BADR or 24% standard rate). This can save the owner hundreds of thousands or millions of pounds in CGT. The conditions include: the EOT must hold a controlling interest, the EOT must be for the benefit of all employees, and the sale must be at market value.

Tax-Free Employee Bonuses

EOTs can pay tax-free bonuses to employees: (1) Up to £3,600 per employee per year (income tax-free, but subject to employer NIC). (2) All employees must be eligible (the company cannot exclude employees, other than those with less than 12 months of service). (3) The bonuses must be paid from the company's profits. The bonus is a powerful incentive for employees and reinforces the benefits of employee ownership.

Conditions and Compliance

To qualify for the EOT tax reliefs, several conditions must be met: (1) Controlling interest — the EOT must hold 51%+ of the ordinary share capital. (2) All-employee benefit — the EOT must be for the benefit of all employees (not just selected employees). (3) Market value — the sale must be at market value (the EOT cannot overpay for the shares). (4) Independence — the EOT must be independent of the company (the trustees must act in the best interests of the employees). (5) Residency — the EOT must be UK-resident. Non-compliance can result in the loss of the tax reliefs and clawback of the CGT exemption.

Key Points

What You Need to Know

EOTs allow business owners to sell to employees with 0% CGT on the sale
The EOT must hold a controlling interest (51%+) of the company
Employees can receive tax-free bonuses of up to £3,600 per year
The EOT must be for the benefit of all employees (not selective)
The sale must be at market value, and the EOT must be UK-resident and independent

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