EOTs – our views on the Budget 2024 changes

The Budget on 30 October 2024 was eagerly anticipated by tax advisers and clients alike. This is not an article about the major tax changes, rather it is looking at the changes announced for EOTs.

The previous government carried out a consultation on the future of EOTs in July 2023 and the HMRC policy paper published on 30 October 2024 covered a number of issues raised in the consultation.

Changes announced

The good news is that the 100% relief from capital gains tax (“CGT”) on a qualifying disposal of shares to a qualifying EOT remains with, surprisingly enough, no upper limit on the amount paid for the shares. Therefore, the whole of the consideration (including deferred consideration) can be paid on a tax free basis.

The rules to qualify for the CGT free payments have been tightened and include:

• The former owners cannot control the EOT, either by themselves or via their relatives
• The EOT trustee must be resident in the UK, so no use of an offshore trustee
• The EOT trustee must take “all reasonable steps” to ensure that the consideration does not exceed market value of the shares and that any interest paid on any deferred consideration does not exceed a reasonable commercial rate
• The period during which the sellers remain “at risk” for the CGT if there is a disqualifying event (which causes the EOT to fail) is extended from one to four years after the end of the tax year in which the sale takes place

There was also a change welcomed by advisers so that any funds contributed by the trading company to the EOT to pay the deferred consideration and the stamp duty payable on the share transfer will not be treated as dividend in the hands of the EOT.

Finally, the payment of the income tax free EOT bonus was tweaked to allow directors of the trading company (or group companies) to be excluded from the receipt of the EOT bonus without breaching the equality treatment (which would otherwise cause the EOT to lose its qualifying status).

The changes take effect from 30 October 2024 and only the provisions regarding the tax treatment of the contributions to an EOT and the payment of EOT bonuses will apply to EOTs formed before 30 October. However, existing EOTs with a UK resident trustee should not look to transfer to an offshore trustee (a tax charge will be triggered).

Our views on the changes

The changes are a welcome tightening of the rules for EOTs. As a Firm, we have followed the changes for existing EOTs as part of “best practice”. Obtaining an independent valuation for the EOT protects the trust (and the sellers) from any allegation in the future that the trust has overpaid for the shares. HMRC have been raising enquiries into the price paid for shares sold to EOTs. An interesting question will be what is required to comply with “all reasonable steps”. A full, tax valuation prepared by a firm of valuers or accountants that is not linked to the company or the sellers will be a starting point.

In addition, if interest is charged on the deferred consideration, what is a “reasonable commercial rate”? Can sellers reference commercial business loans, the higher cost of Private Equity finance or interest charged on credit cards? All can be justified as a “reasonable commercial rate”. Sellers also need to remember that they will be liable to pay income tax on any interest received.

The extension of the “risk period” for sellers will probably make sellers take a closer look at the operation of the EOT and the trading company to ensure that a disqualifying event does not take place. There will be a delicate balance between not controlling the EOT (which causes a disqualifying event) and an element of negative control which is common in minority shareholder agreements.

One trap for the poorly advised will be the sellers controlling the trading company which itself has the power in the trust deed to change the EOT trustee and control other elements of the EOT. The sellers are not permitted to have the power by the trust instrument or “by law” amongst other things to appoint or remove trustees. Where the sellers remain on the trading company board (or have the ability to be appointed), the trading company should not have the power to change the trustee.

Future changes?

It is disappointing that there is no requirement for existing EOTs with offshore trustees to transfer to UK resident trustees. This change would close the loophole that allows an offshore EOT to sell the shares in the trading company without triggering a CGT charge in the trust (the tax charge applies to EOTs with a UK resident trustee). Very few, if any, offshore trustees have UK based employees as directors or trustees which rather goes against the policy of employee ownership and employee engagement.

The future for EOTs

EOTs as a method of achieving a sale are definitely part of the “mainstream” in terms of exit planning. The increase in the higher rate of CGT to 24% from 30 October 2024 and the corresponding reduction in the value of Business Asset Disposal Relief (what was Entrepreneurs’ Relief) will also make the tax benefits of selling to an EOT even more attractive. However, a sale to an EOT may not be the best solution for all companies; sellers should take advice and look beyond the tax savings.

If you would like to explore EOTs as an exit strategy, please contact Andrew Evans or Debra Martin.