Registering Employee Ownership Trusts and Tax on Sale
In this briefing we look at the requirement to register Employee Ownership Trusts with HMRC, even though there may not be a tax liability and the tax consequences should an EOT decide to sell the trading company (and end the EOT).
Registration with the HMRC Trust Registration Service
All EOTs have a potential requirement to register with the HMRC Trust Registration Service (“TRS”) by 1 September 2022. Failure to register your EOT by this deadline could lead to an issue of a penalty for non-compliance. The requirement to register has been brought about by the expansion of the anti-money laundering legislation.
The registration must be made online using the HMRC Gateway authorisation and may require the assistance of an accountant with access to the relevant Gateway if they act for the sponsoring employer company. The registration requirement falls on the trustees, although the sponsoring employers (the trading company) may wish to ensure registration has taken place to avoid any reputational damage involving HMRC.
The requirement to register by 1 September 2022 applies to all EOTs established on or after 5 April 2021 even if the EOT does not have any tax liabilities. Receiving cash from the trading company to pay any deferred consideration will not create a tax liability. Payment of any interest on deferred consideration will create a tax liability because the EOT will be required to deduct income tax at source on any interest payment. An EOT with a tax liability has to register with the TRS (by 5 October following the end of the tax year in which an income tax or CGT liability first arose).
EOTs formed before 5 April 2021 and with no tax liability do not have to register by the 1 September deadline. However, trustees may wish to voluntarily register their EOT to avoid missing a compulsory registration should the EOT trigger a tax liability in the future.
EOTs formed in the future have to register with the TRS within 90 days of formation. Registration should be added to the list of post completion requirements.
Tax consequences of selling the trading company and ending the EOT
We were asked to pitch for a piece of work advising the EOT trustees on the sale of the shares in the trading company after the management team received an attractive offer. This caused us to look at more detail into the tax consequences of a sale of the shares and even we were surprised at the high amount of tax that would be payable.
The sellers are at risk of paying CGT on the sale if the EOT breaches the qualifying conditions by the end of the tax year following the tax year in which the disposal takes place (in simple terms, a maximum 2 year period). The sale of the shares held by the EOT would be a breach on the basis that it no longer controlled the trading company.
Once the seller’s risk period has ended, the CGT risk passes to the trustees of the EOT. The EOT is treated as taking over the base cost of the shares in the company from the sellers. In many cases this could be the nominal amount paid for the shares on incorporation of the company. The whole of the increase in value of the company is taxed as a chargeable gain in hands of the trustee because the trustee is deemed to have sold and reacquired the shares at their current market value. No deduction is given for any deferred consideration due to the sellers.
If the trustee is a company, we can assume a corporation tax rate of 25% from 1 April 2023. The EOT will then be left with a cash lump sum from which it has to pay any deferred consideration. The balance of any money has to be paid to the beneficiaries (the employees) and the payment will be taxed in the same way as a cash bonus, so subject to income tax and National Insurance Contributions, a further 63.3% tax for the highest rate taxpayers. The effective rate of tax would be 72.475%
A company is sold to an EOT 4 years ago, so the tax risk lies with the EOT trustee. The sellers are still owed £8m in deferred consideration. In June 2023, the management team (which includes some of the sellers) receive an offer of £12m for the company which they wish to accept and recommend to the EOT trustee.
The trustee pays corporation tax on the £12m due to the deemed sale and reacquisition rule, so pays £3m in tax.
The sellers receive the £8m deferred consideration (still paid with no CGT).
The EOT trustee is left with £1m out of which it has to pay the costs of the sale (say £100,000), so £900,000 is left to be paid to the employees. If there are 50 employees, they would each receive £18,000 (gross). After basic rate tax and NICs, they would be left with around £9,300 each which is not a brilliant return on the sale of the shares for £12m.
For this reason, the trustees of an EOT need to carefully consider any sale and particularly the tax consequences where there is a substantial amount of deferred consideration outstanding. A sale to an EOT should be considered a long term ownership of shares. Any sale has to add up from a tax and financial point of view.