Archives November 2024

Understanding Employee Ownership Trusts


Introduction to Employee Ownership Trusts

Employee Ownership Trusts have grown in popularity over the past few years with an attention grabbing headline of ‘NO CGT IF YOU SELL YOUR COMPANY TO AN EOT’.

In this article, we’ll do a little digging into Employee Ownership Trusts to see if the attention grabbing headlines are a bit too good to be true.

What is an Employee Ownership Trusts?

An EOT is a type of trust that holds shares in a company on behalf of its employees. Unlike direct employee ownership, where employees are shareholders, the EOT allows employees to benefit from the company’s success without actually holding shares themselves.

This structure is designed specifically for trading companies as non-trading entities (such as investment companies) do not qualify.

Key Features of an Employee Ownership Trusts

To qualify as an EOT, the trust must own more than 50% of the company’s shares and voting rights. This creates a separation of ownership and management, where the trustees are the legal owners of the company and act in the best interests of the employees.

Meanwhile, the existing management team can continue to run the day-to-day operations.

The Impact of Employee Ownership Trusts: Stats…

As mentioned earlier in this article, employee ownership through EOTs is fast gaining popularity. As of October 31, 2023, there were over 1,650 employee-owned businesses in the UK, with approximately 330 new businesses adopting this model in the previous 12 months. The benefits appear to be clear with:

  • 57% of these businesses reported increased profits.
  • 83% saw a rise in employee engagement.
  • 73% noted improved job satisfaction.

What are the Advantages?

From the stats above, EOTs offer several compelling benefits:

  • Enhanced Productivity: Employees tend to be more engaged and motivated when they have an interest in the businesses success. This drives productivity.
  • Legacy Protection: The business owners can protect their legacy while facilitating a leadership succession over time.
  • Financial Benefits for Owners and Employees: Owners can access the value they’ve created, and employees can receive annual tax-free bonuses of up to £3,600. Additionally, the sale of shares to an EOT can be tax-free if done within the same tax year, offering significant capital gains tax relief.

What are the potential drawbacks?

Despite the apparent advantages, there are some challenges to consider:

  • Limited Participation: The sellers of the business generally can’t be beneficiaries of the trust, meaning they must relinquish control.
  • Mental Adjustment: For original owners, losing control of the company can be a significant psychological hurdle.
  • Valuation Risks: If HMRC suspects the company’s valuation is overstated, it may classify excess value as employment income, triggering tax liabilities under disguised remuneration rules.
  • Restrictions on Tax-Free Payments: Bonuses can only vary based on specific criteria like remuneration, length of service, or hours worked. Failing to comply with these rules could jeopardise the EOTs status.

Are there many risks?

The risks associated with EOTs can be pretty severe:

  • Tax Benefits Withdrawal: If the Employee Ownership Trusts loses control of the company or the company ceases trading, the associated tax benefits can also be withdrawn.

In such cases, the EOT may be deemed to sell its shares at market value, potentially incurring capital gains tax without having the cash to cover it.

  • High Tax Rates on Sales: If the Employee Ownership Trusts sells the company, it assumes the seller’s base cost, meaning it pays tax on the held over gain. Any distributions to employees are taxed as employment income, which can be costly (particularly for higher earners).
  • Considerations for Sellers: Sellers must consider the impact on any shares they retain and the potential Inheritance Tax (IHT) implications, particularly if deferred consideration is involved. Fixed term insurance might be necessary to cover IHT exposure.

Ok, I’m still interested…….what are the practical considerations for setting up an Employee Ownership Trusts?

Setting up an Employee Ownership Trust requires diligent planning:

  • Trustee Identity and Location: There are ongoing consultations about requiring a UK residency for the trust and the inclusion of at least one independent trustee.
  • Funding Considerations: Contributions to the Employee Ownership Trusts to fund share purchases may be treated as dividends for tax purposes, so it’s crucial to seek advice.
  • Dividend Payments: Receiving dividends can be tax-inefficient for the trust, and deferred consideration periods pose risks for sellers.

Summary

Employee Ownership Trusts can offer significant benefits for businesses and employees, but they come with complex requirements and potential risks.

If implemented for the right reasons, an Employee Ownership Trusts can drive productivity, protect a business owner’s legacy, and provide financial rewards for employees. However, tax incentives should not be the sole motivation for establishing an EOT. Given the numerous qualifying criteria and the serious consequences of disqualification, it’s essential to seek specialist tax and legal advice before proceeding.

The team at ETC Tax have a wealth of experience in dealing with employee ownership trusts. If you are a trading company and want more information about Employee Ownership Trusts please get in touch.



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TPP Q & A November 24


We have supported our Tax Partner Pro members via email and call-back service. Here’s an overview of some of the more recent questions we have answered during November 2024

Q

Could I have some information on the 10-year anniversary trust return completion, I have looked at HMRC and its very contradictory.

My client has a trust this has a GIA ( originally investment £66,500), the income is generated from dividends and interest from the GIA portfolio of stocks and shares (2024 was < £1,000.00)

Does the client fall into the category to report its 10 year anniversary?

What does qualify a trust to complete a 10 year anniversary form?

A

In general, if the trusts assets are valued at less than 80% of the NRB then it would be an excepted estate and no 10 year anniversary charge return is required.

Q

We have a client how earns £488,000 through PAYE per year gross and is having RSU Gains and Tax withheld through his payslip.

Are there any additional disclosures we need to make on the self-assessment other than reporting the P60?

A

No there shouldn’t be. The income has been declared and the tax paid via PAYE so just the P60 is all you’d need.

You’ll need to report on the CGT pages when the shares are sold if there is a gain to be declared.

Q

I have a one person company client who is considering ceasing trading as his last trading receipt was in January, though he has just quoted for a small project and is waiting to hear if it will go ahead. Meanwhile, he’d like to make a £60,000 pension contribution from the company. My concern is that – especially if the small project does not materialise – that the contribution will be 9 months after the last trading receipt and may not be allowable for corporation tax – being considered part of the process of closing the company down rather than say part of the director’s remuneration.

A

My concern would mirror yours, as the business appears to have ceased to trade.

Contributions made as part of the arrangements for going out of business, in particular where there is no pre-existing contractual obligation to make such a contribution, are not considered as meeting the ‘wholly and exclusively for the purpose of the trade’ test.

In the case of CIR v Anglo Brewing Co Ltd [1925] 12 TC 803, the company decided to close down its business. In the past, the company had granted pensions to employees on their retirement. The company promised to treat its present employees with equal generosity. The company therefore agreed pension amounts (which were later commuted for lump sums) and compensation payments. The company claimed the costs as a deduction in computing its profits.

The high court took the view that the payments were made for the purpose of winding up the company and that no deduction was due for the pensions or the compensation. There is now a statutory relief for redundancy payments but the principle of the decision, that payments to go out of business are not allowed, remains valid.

Q

I have a client who is a musician. He is looking to “book some music related events next year for research purposes in order to keep track of current and new trends in the electronic music market. “

 He has asked me about whether this is tax deductible.

 I am aware of wholly and exclusively and have shared this with him but he’s shared with me an example of a business package referencing VAT etc  

I am not sure what to advise. It makes sense for him to attend these events for research but by the letter of the law is looks like it could be entertaining it and then would it be disqualified in full!! I cannot find any similar case law.

 Are you please able to advise?

A

I think it would be hard to justify this as an expense and would expect HMRC to disallow if challenged.

You could perhaps claim a portion of the cost and argue that there is a duality of purpose but I’d emphasise the risk of it being disallowed if HMRC were to challenge it.

That being said, in an article in Tax Weekly magazine in May 2024 there is some commentary on this and the adviser quoted “If a performer incurs research expenditure to research their role, such as attending performances, this will probably be allowable.”

 I note the commentators use of the word ‘probably’ in that passage as it’s a subject that no one will be able to offer iron clad case law backed opinion on the matter.

 I’d suggest making the client aware of the risk, but ultimately letting them make the call on it.

Q

We have a client who invested in a US fund (not listed in HMRC’s reporting fund listing) in the last 2-3 years and according to her financial advisers, the fund is making losses. She is looking into selling the fund to realise the losses. From reading HMRC’s manual IFM13550, I understand the losses would be treated as a capital loss – please confirm that my understanding is correct?

Furthermore, could you also please confirm that the above losses can be offset against capital gains arising (in the same year/future) in the normal way.

A

Yes, the losses will be capital losses and relievable in the normal way (against current year or future years capital gains)

Next Steps

Do you have any questions similar to the above, could Tax Partner Pro membership be right for you? Don’t hesitate to get in touch with ETC Tax to find out more.



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Non-Doms Granted Easy Exit


Upcoming changes to the UK’s tax regime for non-domiciled individuals (non-doms) may inadvertently deepen the fiscal deficit. The Government’s newly introduced transitional rules, to take effect in April 2025, could accelerate the departure of non-doms, thus reducing potential tax revenue.  

A Lucrative One-Way Ticket?

The new rules, effective from 6 April 2025, will end the current reliance on domicile as a tax-defining factor. For a long time, the UK has been the only country to consider an individual’s domicile status. Instead, a person’s tax residence will determine whether their worldwide income and assets fall under the UK’s IHT regime. Non-doms who have been UK residents for at least 10 of the past 20 tax years will be subject to IHT on their global assets, even after they leave for a period of ten years (known as the Ten Year Tail).

However, the proposed transitional rule allows non-doms planning to leave the UK next year to avoid this new 10-year IHT tail, creating a short-term lucrative opportunity for those already considering relocation.

Impact on Offshore Trusts

The reforms will also have significant implications for trusts. Currently, trusts holding non-UK assets are typically exempt from IHT as long as the settlor is not UK-domiciled. From April 2025, however, the trust’s IHT status will depend on the settlor’s residency status.

Previously, a trust could shift in and out of the inheritance tax system depending on whether the settlor was deemed a long-term UK tax resident. This introduces added complexity for trustees, who may not always maintain regular contact with settlors over time.

Trustees could also face an “exit charge” on non-UK assets if the settlor ceases to be a long-term resident.

Urgent Decisions for Non-Doms

With only a few months until the rules take effect, non-doms need to consider whether to relocate to countries with more favourable tax regimes, some of which offer zero IHT.

Next Steps

As the deadline for the new rules approaches, please do get in touch if you require any UK tax support.



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Martin Lewis: Five things EVERYONE needs to know about student finance 2025/26


Be careful who you listen to on Student finance. There’s a lot of nonsense spoken. And even when you’re getting facts, be wary, it has changed so often, the way it works for is different even for some still at Uni now, never mind those who graduated a decade ago. So I want to explain the practical impact on your pocket – which is radically different to the more political spin you will usually hear. 



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Martin Lewis: Letter responding to the Chancellor on Lifetime ISAs, Child Benefit, Student Loans and mid-contract broadband &amp; mobile prices rises


On the 9 January 2024, Jeremy Hunt the Chancellor of the Exchequer was a guest on ‘ITV The Martin Lewis Money Show’, it was a wide ranging consumer finance interview, you can watch it here. As part of it when I was pushing some key campaigning points, his response was to ask me to write to him. Below is the letter sent today (which I will also send to the shadow chancellor Rachel Reeves)…



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Re-domicile of a company 


Case of the month

Introduction

Prior to 2013 it was fairly common for an offshore company (Offco) to hold UK residential property. Whilst rental income was taxable, the company would not be liable to capital gains tax (CGT) nor would the non-domiciled shareholders be liable to IHT.

Even taking into account the high costs of running an Offco, this was a cost effective way of arranging property ownership.

Issue

Following various changes in legislation over the years, the company is now also liable to capital gains tax and the shares subject to Inheritance Tax. There are no advantages to having an Offco and the client wanted advice on transferring ownership to a UK company tax efficiently and to save significant ongoing admin costs.

How we solved it

We advised the client to set up a new UK limited company and for the Offco to become UK resident. By complying with the relevant legislation the properties could be transferred to the UK company with no CGT or SDLT costs.

The outcome

The overseas shareholders now own a UK company owning the properties at their original base cost and the shareholders have considerably less annual admin costs.

Note however the value of the shares is potentially liable to UK IHT, regardless of the shareholders’ domicile status.

Next Steps

If you have a case similar to the above or would like more information on re-domicile of a company please get in touch.



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