Employee Ownership Trusts (EOTs) - Compliance

Compliance is usually placed in the same box as “governance” – not very sexy unlike the fun topics of employee engagement and improving the life of employees in the business. However, ensuring good compliance alongside governance provides a solid foundation for all the fun stuff in the employee ownership environment.

What is compliance and why is it important?

Compliance has many different areas:

• Satisfying the obligations of the EOT deed and trustee duties
• Satisfying the registration and filing obligations of an EOT
• Satisfying the tax and company law requirements for the payment of the deferred consideration

This article will not touch on the first point as it vers too much into the “governance” box and the article would be far too long for most readers. Getting the basic compliance obligations right can allow the trustees to concentrate on their primary obligation of protecting the interests of the beneficiaries by holding the trading company board to account in the operation of the business. It also ensures that the fundamental tax aspects of an EOT are not put at risk.

Registration and filing obligations

The basic obligation is to ensure that all EOTs formed after 1 September 2022 are registered with the HMRC Trust Registration Service within 90 days of the formation of the EOT. Registration is made via the HMRC online gateway. EOTs formed before 1 September 2022 were also required to register. It is safe to say that all EOT advisers are aware of the registration requirement.

If the EOT trustee is a company, that company is required to file annual accounts with Companies House. The accounts may be very simple if the company is treated as dormant (more comment on this point later). There are also requirements to file a confirmation statement each year regarding the members and keep the register of Persons with Significant Control up to date. Changes in the identity of the directors of the company trustees will need to be filed. All directors and shareholders of UK companies have had to register their ID with Companies House by the time of filing the company’s next confirmation statement.

The EOT itself will have to prepare annual accounts as a trust. The accounts will show the shareholding in the company owned by the EOT together with any liability outstanding to the sellers as deferred consideration. The change by HMRC in their interpretation of the legislation governing distributions and the tax treatment of payments from the company to the EOT will also have an impact on the EOT’s accounts.

EOTs formed on or after 30 November 2024 will need to file a tax return and claim relief from income tax on payments received which qualify for the tax relief (see section below on tax and company law obligations).

Remember, any EOT bonus is paid by the employer company and not via the EOT. The employer company will want to ensure compliance with the equality treatment (see our article on the EOT bonus here) and ensure that the National Insurance Contributions are paid via PAYE.

The EOT will also have to ensure that the trustee independence test is satisfied on an ongoing basis for EOTs formed on or after 30 October 2024. The independence test requires that excluded participators, which basically means the sellers (and their associates) comprise less than 50% of the trustees or directors of the trustee company and do not control the EOT. Although there is a six-month window for replacements on the death of a trustee or director, there is no such window for a sudden resignation or even a planned resignation. A breach of the independence test is a disqualifying event and will trigger a capital gains tax liability for the seller or the EOT depending on the length of time since the transition to EO.

Deferred consideration and EOT expenses – tax and company law obligations

The rules on the payment of the deferred consideration changed dramatically from 30 October 2024 when the Budget announced changes to the treatment of contributions from the trading company to the EOT to fund the consideration for the shares. The provisions of the Finance Act 2025 introduced relief from tax in the hands of the EOT for some payments, primarily the completion consideration, repayment of loans obtained to pay the consideration, the deferred consideration, interest on loans to pay the completion consideration and on the deferred consideration and the costs of the transition. HMRC also published revised guidance on their interpretation of the treatment of distributions – payments from the trading company to the EOT.

Pre-transition payments

The question of the payment of the initial payment to allow the EOT to buy the shares at completion is a grey area. On the one hand, the EOT is not a shareholder at the time the contribution to the EOT is made and therefore the contribution is not a distribution. The alternative argument is that the payment is made in anticipation of the EOT becoming a shareholder and consequently the payment is a distribution. The safest course of action is to treat the initial payment as a distribution. The consequence is that the procedure set out below for post-transition payments to approve a distribution will also apply.

Problems may arise if the target company does not have sufficient distributable reserves to cover the payment of the initial consideration, particularly if borrowings are being incurred to pay the initial consideration. Where there is a shortfall in distributable reserves, the structure of the consideration will need to be altered and the lender may have to lend direct to the EOT trustee rather than a loan to the target company. Lending to the EOT will have an impact on the security that can be offered to the lender.

Post-transition payments

Once the EOT becomes a shareholder, any payment from the trading company (or a holding company) will be treated by HMRC as a distribution. This means from a company law point of view, the paying company must have sufficient distributable reserves to pay the cash amount to the EOT. A payment made where there are insufficient distributable reserves will be an unlawful dividend. The payment is a breach of the directors’ duties and can be set aside in the event of the insolvency of the company making the payment. Directors could be required to repay the dividend as could the EOT if it was aware that the dividend was unlawful.

The directors of the trading company should fully document the payment of the dividend including:

• Reviewing the last statutory accounts and the financial position since the last accounts, so the current trading position and management accounts.
• Directors’ duties regarding the solvency of the company and its ability to pay its future liabilities. The company may not have a legal obligation to make the payment to the EOT.
• Acting in the best interests of the company, its employees and shareholders (the EOT and any minority shareholders).
• The exercise of reasonable care, duty and skill in reaching the decision to pay the dividend.

Filing tax returns with HMRC

EOTs created on or after 30 October 2024 will have to file a tax return and claim tax relief for the payments received from the paying company. The position of EOTs created before 30 October 2024 will depend on the terms of any non-statutory clearance obtained prior to the transition. A “cautious” and perhaps better approach would be to file the tax return and claim the relief. HMRC will know about the payments of the deferred consideration from the tax returns of the sellers (claiming CGT relief on the consideration) so there is no need to try and hide the payments.

On-going trustee expenses

The ongoing expenses of the EOT trustee should be considered. The trustee will incur expenses of the preparation of the accounts, filing the tax returns and accounts, and possible payments to the independent chair of the trust. The payment of these expenses by the trading company would be treated as distributions to the EOT. The EOT may not incur a tax liability as it will be using the distribution to pay its expenses so there will be no excess income. The payment of these expenses may mean that the trustee company is not dormant (because it has accounting entries) which has an impact on the type of accounts that need to be prepared and filed at Companies House.

Conclusion

EOT compliance is not straightforward. There are a lot of basic filings to be completed for the EOT and the trustee company. The question of what is a distribution and ensuring compliance with the company law rules on lawful distributions adds even more complexity to the operation of an EOT.

EOT compliance is one of the topics covered at the Wales Employee Ownership conference on 11 June, here is the link for more information.

If you would like to discuss the issues raised in this article or EOTs more generally, please contact Andrew Evans or Debra Martin.