Employee Ownership Trusts Bonuses: What are the benefits?

EOT bonuses are usually the most tangible benefit of employee ownership for employees and one of the main financial advantages for employees, who may receive income tax-free bonuses of up to £3,600 each per year, subject to certain eligibility criteria.

The last roundtable event for employee-owned businesses hosted by Geldards in 2023, focused on the calculation and distribution of tax-free bonuses to the employees of businesses owned by employee ownership trusts (“EOTs”).

Who is eligible?

The tax-free bonus must meet the “participation” and “equality” requirements to be exempt from income tax:

1.      Participation requirement: any bonuses must be made available to all employees in the EOT group, although a minimum qualifying period (of up to 12 months) is permitted. The sellers are entitled to receive the EOT bonus (and should receive it if they are employees unless they waive their entitlement); and

2.      Equality requirement: the eligible employees must participate on the same terms. However, the business does have some discretion in how it chooses to allocate the bonuses and may take into account employees’ salary, length of service, or hours worked.

The calculation methodology must not enable weighting to certain groups of employees. It is critical that the equality treatment is not infringed, as any bonuses paid outside the equality treatment would then become subject to income tax. In addition, and probably more importantly, a breach of conditions would result in the EOT losing its qualifying status, resulting in a hefty tax bill to either the sellers or the EOT (depending on the length of time since the transition to employee ownership).

For transparency and employee engagement purposes, it is best practice to adopt a formal policy about how employee bonuses are calculated and ensure that the policy is communicated to employees.

Tax-free bonus amount

Provided the qualifying conditions are met, each eligible employee of the EOT group can receive up to £3,600 of bonuses per year, exempt from income tax. The EOT bonus can be spread throughout the year and does not have to be paid in one lump sum.

The tax-free bonus will be paid by the trading company rather than the EOT. The total amount available for distribution to the employees is decided by the trading company board, taking into consideration factors such as:

·      profitability;

·      normal expenditure;

·      tax liabilities;

·      future expenditure or investment in the business; and

·      upcoming deferred consideration payments to the sellers.

A recommendation is then made to the trustee board regarding the allocation between employees with the trustee board having the final sign-off on the allocation.

Deciding on the allocation

Many EOTs decide on the same amount being paid to all eligible employees on the basis it is fair to pay everyone the same amount as all employees make the same effort in contributing to the success of the business. Paying the same bonus to the junior staff members and the CEO can generate a “togetherness” in the workforce. Exceptional individual performance can be rewarded by normal bonuses. The salaries reflect the rewards for responsibility and the requirement at the leadership levels to make difficult, strategic business decisions.

Some businesses do pay an EOT bonus based on a percentage of salary. The John Lewis Partnership is a good example. Allocations based on hours worked can be an easy decision so that part-timers receive a pro-rata amount. For example, it seems fair that someone working two days a week should receive 2/5th of the bonus paid to an employee working 5 days a week.

We have seen some companies pay a differential based on length of service. Our view is while this approach can be justified in the first few years of EO to reward the members of staff who have helped grow the business, continuation of the differential, once EO has been established, can be harder to justify on the basis the newer members of staff may be working just as hard as the longer serving staff.

It is important to remember that the allocation can change from year to year. However, any changes and the reasons for the changes must be clearly communicated to the employees.

Communication is key. Employees may have remembered the £3,600 figure from presentations leading up to the transition to EO. If the business knows that it cannot afford to pay the full £3,600, it needs to communicate this to the staff at an early stage and manage expectations. The receipt of any EOT bonus that is income tax-free should be celebrated and companies should avoid a payment below expectations being received negatively. The payment of the first EOT bonus can also set a benchmark for future bonuses.

Conclusion

The concept of the £3,600 EOT bonus is easy to understand. However, in practice, deciding on the allocation and communicating the decision to employees can cause some difficult issues if not dealt with correctly.

Geldards have supported many businesses in all aspects of employee ownership. If you would like to discuss employee ownership or its benefits, including the employee bonuses, or would like to be kept updated about our next EOT roundtable event, please contact Andrew Evans or Debra Martin. If you would like to attend our next EOT event on how to improve employee engagement, you can sign up here