EOTs – their time to shine

Given the Chancellor’s increase of capital gains tax (CGT) rates, the changes could encourage more businesses to consider EOTs as an alternative exit option – and require them to get to grips with the necessary processes involved in this transition.

How has the government changed the rules on EOTs?

Key changes introduced for EO in the Budget include a new obligation on trustees to ensure the EOT does not pay more than market value for its shares. This will see a significant overhaul in how EOT conversions are conducted, including setting up the trustee body earlier so that they can show they have met their new legal obligation.

The sale of a business to an EOT involves establishing a trust over the shares and creating a trustee to hold the shares on behalf of the business’ employees. To date, the trustee has often been set up much later in the EOT sale process and is not separately advised, with the trustee taking the deal “as seen”. Business owners must acclimatise to these changes, as well as increased scrutiny from the HMRC which means selling owners must now disclose the number of employees in the business, and the funds received for shares when they undertake tax returns.

It’s clear the government intends to establish good practice for EOTs. The changes are designed to make the rules easier to follow and practices more transparent. For instance, business owners no longer have to apply to the HMRC for clearance for EOTs for distributions or mandating how the Board must be constituted.

The composition of EOT trustees has changed too. Selling shareholders may no longer have control of the trustee company, if the disposal to an EOT is to qualify for relief. Giving de facto control via the trust deed will be impossible for EOTs established after 30^th October 2024 although others would be wise to follow suit to avoid HMRC scrutiny.

Other amendments include:

• Stopping EOTs being registered out of the UK.
• Enabling EO businesses to pay tax-free bonuses to employees alone.
• Extending the period that vendors of shares are responsible for any ‘tax clawback’ to the fourth year following disposal.

Whilst the EO route is often deemed to have less financial gain for business owners looking to exit, the new tax change could level the playing field. That said, the EO reforms are more prescriptive and robust than ever before so businesses considering EO must get to grips with expectations for good practice and exercise good financial hygiene and management of the business.

Key takeaways

With more than two thirds of SMEs intending to sell or divest their shareholding in the next decade, the new rule changes should make EO a much more viable and attractive alternative. For those considering taking the leap, here are some important actions to consider:

• Don’t jump ship without due diligence. Is EO what’s best for the business?
• Take time to understand the new rules and requirements before choosing EO. Will there be challenges in satisfying HMRC’s expectations?
• Think about how the business will be run after EO conversion. Are you prepared to let go?

For more information, please contact David Alcock.

• Share this