What are the Specific Tax Benefits for Sellers When Transferring Their Business to an EOT?

Employee Ownership Trusts have emerged as the most attractive option for the business owner who wants to sell his or her business with substantial tax advantages. The government in the UK has implemented these incentives to encourage employee ownership of businesses, thereby extending a number of major benefits to sellers who opt for this route. As a result, employee ownership trust valuations have become a popular topic over the recent years.

The most compelling tax benefit available to sellers who transfer the business to an EOT is a complete exemption from Capital Gains Tax. Where an EOT acquires the controlling interest in a company, the seller will not be liable to pay any CGT on the full market value of their shares. The whole amount is exempt, which is particularly beneficial compared with other tax relief schemes, such as BADR, which has a lifetime limit and is also subject to increasing rates in the coming years.

Qualifying Conditions for Tax Relief

To qualify for this CGT exemption, several conditions must be met. The company being sold must be a trading company or the principal company of a trading group. The EOT must acquire a controlling interest (more than 50%) in the company as a result of the sale, and this controlling interest must be maintained at the end of the tax year in which the transfer takes place.

Beyond Capital Gains Tax: Additional Tax Advantages

In addition to exemption from CGT, the sellers will also get relief from income tax and inheritance tax, provided certain conditions are met. The sale should not be subject to income tax; this is also a financial benefit for the seller. Also, there's no charge to inheritance tax on the gift of shares to an EOT, and the EOT itself will be exempt from the Inheritance Tax relevant property regime.

Flexible Consideration and Tax Planning

It's worth noting that the tax benefits extend beyond the immediate sale. In a sale where the purchase price is considered deferred consideration, there may be possibilities to spread the taxes payable over a longer period. It could, therefore, ensure higher tax efficiency, too, together with financial security in the post-sale business venture.

Navigating Valuation and Compliance

Nevertheless, for the transaction to retain its tax-advantaged status, sellers have to be careful that all the qualifying conditions are met. The business has to be valued at a market value; otherwise, HMRC would challenge it, and the trustee also has a fiduciary obligation to act in the best interests of employees not to overpay for shares.

Recent Regulatory Changes

Recent changes to EOT rules, effective from October 30, 2024, have introduced new restrictions on connected persons benefiting from an EOT. These changes aim to prevent duplication of tax relief for sellers and their families. These changes do not impact the main EOT disposal criteria but may impact the ability of sellers to obtain inheritance tax relief on the disposal of the company to the EOT.

In Summary: A Strategic Exit Strategy

To wrap things up, the tax benefits to the seller who transfers their business to an EOT are not only significant but multifold. From CGT exemption to potential relief on income and inheritance tax, EOTs offer a tax-efficient exit strategy that aligns the interests of business owners with those of their employees. As the landscape of business valuation services for SMEs continues to evolve, EOTs represent an increasingly attractive option for sellers looking to maximise their financial outcomes while ensuring the continued success of their business under employee ownership.