CGT rates rise and the Employee Ownership Trust (EOT) regime reformed: now is the time consider sale to an EOT

At midnight on 30 October 2024, while many of us slept in eager anticipation of the new labour government’s first budget, the rate of Capital Gains Tax (CGT) increased. 12 hours later the Chancellor announced the higher rate of CGT had increased by 4%. The hike is less drastic than feared and seems unlikely to cause sellers too many sleepless nights.  

Nevertheless, it is a tax hike and combined with an increase in the rate of CGT when applying Business Asset Disposal Relief (BADR) those selling businesses may wish to consider alternatives. One such option is to sell the business to an Employee Ownership Trust (EOT). Such a sale attracts no CGT and places employees at the heart of the business going forward. Additionally, the government’s announcement of a package of reforms to the EOT regime means that the process of converting to an EOT is clearer and more streamlined than ever before.  

Increase to Capital Gains Tax (CGT) and Business Asset Disposal Relief (BADR)

The lower rate of CGT has increased from 10% to 18%, the higher rate from 20% to 24% and the rate that applies to trustees and personal representatives from 20% to 24%, The rates of CGT that apply to residential property disposals will remain unchanged, the lower rate currently sits at 18% and the higher rate at 24%.

The CGT rates for Business Asset Disposal Relief (BADR), previously called entrepreneurs’ relief, which can apply to the first £1 million of sale proceeds when a sole trader, business owner, director or certain others sell their business, are set to increase incrementally. On 6 April 2025 rates will rise from 10% to 14%, and the following year on 6 April 2026 they will further increase to 18%. Investor Relief (IR) will increase in the same manner and in addition, the lifetime limit for IR will be reduced from £10 million to £1 million for all qualifying disposals made on or after 30 October 2024, matching the lifetime limit for BADR. Whilst less significant than many predicted, these increases are still a blow to those selling a business.

Although increases of this size aren’t likely to act as a total deterrent to sale, those selling a business will be particularly hit by the hikes.

Employee Ownership Trusts (EOTs): reform and clarity

Following the previous conservative government’s consultation on EOTs, the new Chancellor announced a package of reforms aimed at ensuring EOT sales are focused on promoting employee ownership and rewarding employees. Key reforms include:

Relaxation of the participation and equality requirement: no need to give directors bonuses

Legislation will be amended to allow for the exclusion of directors from the up to £3,600 tax free bonus EOT controlled companies can award each employee. This provides businesses greater flexibility to tailor the benefit scheme and makes the bonuses more efficient to administer.

Removal of HMRC clearance requirement and legislative confirmation that funding payments are free of income tax

The government will introduce legislation confirming that payments made to the trustees of an EOT (usually directly from the business) to fund the purchase price paid by the EOT (and other costs) are not distributions and are free of income tax. As a result, from 30 October 2024, provided an EOT is established for genuine commercial reasons and no tax avoidance purpose is present, HMRC will no longer provide clearance to companies. This helps to clarify the position on start-up payments and should reduce the cost and increase the speed of setting up an EOT.

Restrictions on former owners’ control of the EOT post-sale

Further restrictions have been placed on former owners’ ability to control the EOT. These measures are designed to ensure that transition to an EOT structure is genuinely to encourage employee ownership and reward employees. With effect from 30 October 2024, the majority of the trustees of an EOT must consist of persons other than the former owners, persons connected with the former owners, companies under the control of the former owners or connected persons, or companies where half or more of the directors are former owners or connected persons. Additionally, the trust deed must not provide power to these persons to exercise control over the EOT.

Breach of these conditions at any time following disposal could be a disqualifying event, which would lead to a CGT charge. Therefore, owners setting up an EOT after 30 October 2024 must be careful to ensure these requirements are met and ought to seek legal advice on the content of the trust deed and the constitution of the board of trustees.

Closing the offshore loophole for tax purposes

From 30 October 2024, for a disposal to an EOT to qualify for relief the trustees of the EOT must be a UK resident (as a single body of persons). A breach would also trigger a CGT charge to the trustees. This ensures that if an EOT controlled company is later sold CGT will be paid in the UK. Again, failure to comply with this requirement is a now a ‘disqualifying event’ that will result in a CGT charge.

Extension of the vendor clawback period

The government has increased the ‘vendor claw back’ period during which CGT can be charged to the former owner(s) if a disqualifying event occurs. The period has increased from two to four years. Breach of the EOT conditions within the four years following the year of disposal allows HMRC to collect CGT on the sale from those who sold to the EOT. After four years, the tax is instead charged to the EOT.

Additional duties on Trustees

From 30 October 2024, all Trustees now have a duty to take all reasonable steps to ensure that the consideration paid to acquire the shares does not exceed the fair market value at the date of disposal. All Trustees have fiduciary duties to act in the best interests of the trust, and so in many ways this measure simply confirms and emphasises the existing position.

More information for HMRC

Owners will now need to provide information about the consideration they have received for their shares, and the number of employees of the company at the date of disposal to HMRC when they claim the CGT relief within their Self-Assessment Tax Return. This information is aimed at allowing HMRC to better monitor and evaluate the CGT position on sale (checking various requirements were met).

Summary

These reforms close down a couple of “loopholes” with EOTs, provide useful clarification and help to streamline the EOT regime. With the hike in CGT rates and growing social importance of giving employees an active stake in their employers, EOT’s are an increasingly attractive option to sellers. However, the conversion process is complex and the risk should an error be made it significant. It is vital to access expert legal and accounting advice when embarking on the process of sale to EOT. 

KN’s Corporate and Commercial team are experienced in advising on all aspects of the EOT formation and sale process.

Further information

If you have any questions regarding this blog, please contact Matt Spencer or Caitlín Comins in our Corporate, Commercial & Finance team.

About the authors

Matt Spencer is a partner within the Corporate, Commercial and Finance team, specialising in tax law, advising on and efficiently structuring a wide range of corporate and real estate transactions including M&A, land transfers, developments and leases.

Caitlín Comins is a Trainee Solicitor at Kingsley Napley and is currently in her first seat with the Corporate and Commercial team. She joined the firm in September 2024.