Employee ownership rules to be toughened over tax misuse

Ministers have put forward proposals to prevent employee trusts being used for tax purposes rather than for the benefit of employees.

The previous government launched a consultation on the issue in July 2023. The responses have now been considered and fresh measures set out after the Budget that attempt to close tax loopholes without being so restrictive as to make the model less attractive to businesses.

Employee trusts are set up for the benefit of the employees or office holders of a company. For tax purposes these are often referred to as employee benefit trusts (EBTs). Employee ownership trusts (EOTs), meanwhile, are a specific type of EBT whereby the trustees own the company, and exercise control of the company for the benefit of all the employees.

The Chartered Institute of Taxation (CIOT) is among bodies that have pointed out that such trusts have, in some cases, been advanced as a tax-saving solution for business owners who can sell their company to an EOT or EBT, and pay no capital gains tax, without any genuine intention for the company to be owned and ultimately controlled by its employees.

Christopher Thorpe, a technical officer for the CIOT, said last year during the consultation: “As well as tackling potential abuse, our main concern is to ensure the EOTs fulfil their original intention and sentiment. The main benefit, at the moment, lies with the former owner who may qualify for CGT relief on the creation of the settlement, whereas the only benefit for employees is the £3,600 income tax-free bonus.”

EOTs are given tax-favoured treatment through tax reliefs which were introduced in 2014.

However, both the previous government and current Labour administration have sought to ensure that the favourable tax treatment remains available to those who use EBTs and EOTs for the intended policy purposes, while preventing tax advantages being obtained through use of these trusts outside of these intended purposes.

The proposals, to be introduced in the Finance Bill of 2024, will include the restriction of former owners from retaining control of companies post-sale to an EOT by virtue of control of the EOT.

Trustees of an EOT will also need to be UK residents at the time of the sale of the EOT.

The government will also seek to extend the period of time within which the relief can be withdrawn from the former owner if the EOT conditions are breached post-sale, to the end of the fourth tax year following the tax year of disposal.

A further requirement will see trustees taking reasonable steps to ensure that the consideration paid to acquire the company shares does not exceed market value. The forthcoming legislation will also require that no more than 25% of employees who are able to receive income payments from an EBT should be connected to the participators of the company.

Ministers say they will monitor the effectiveness of these reforms to ensure that the EOT and EBT reliefs are not abused to obtain tax advantages contrary to the policy objectives. Future policy developments may be informed by the effectiveness of the reforms to prevent abuse.

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