New statistics obtained from a Freedom of Information request made by RSM UK show that there has been a ten-fold increase in clearance applications to HMRC for Employee Ownership Trust (‘EOT’) structures in the last two years.
If a company plans to become employee-owned, the shareholders of that business will often seek to sell a majority stake to an EOT and benefit from a highly beneficial zero per cent Capital Gains Tax (‘CGT’) rate on the sale proceeds.
Prior to doing so, a ‘clearance application’ will typically be made to HMRC to confirm that they will not seek to apply certain tax anti-avoidance rules, known as the ‘Transactions in Securities’ rules. These rules can be punitive and could potentially subject sale proceeds to an income tax rate of up to 39.35 per cent if they are applied.
In 2019, a total of 38 companies made a ‘clearance application’ to HMRC, relating to sales or transfers to an EOT. In 2020, this increased to 100 companies and in 2021, it increased again to 383 companies. In the first four months of 2022 alone, 123 companies have already made a clearance application.
What is driving this increase? Over the last decade, the government has been keen to encourage more businesses to become employee owned, with research indicating they can increase both profitability and productivity. High-profile examples include retailers John Lewis and Richer Sounds.
An independent report in 2012, the Nuttall Review, highlighted some of the barriers to encouraging more employee-owned businesses. As part of the response to this, the government introduced tax incentives in 2014 that can provide for a zero per cent CGT rate on the sale of shares to an EOT and the ability for staff to receive an income tax-free annual bonus of £3,600.
The statistics in 2019 highlight the number of companies in the UK applying to HMRC to become employee owned was relatively modest but momentum is growing for this type of ownership structure in the UK. Part of the impetus behind this growth will be the significant changes made to Entrepreneurs’ Relief in 2020, limiting the tax relief for business owners from £1 million of tax savings to £100,000 during their lifetime. When a 10 per cent tax rate was available on £10 million of sale proceeds, many business owners disregarded the possibility of an EOT transaction due to the various criteria that needed to be met to qualify for the preferential zero per cent CGT rate.
As the economy begins to falter, it could lead to a slowing of the M&A market, making it harder for business owners to sell up to traditional buyers. We could therefore see further increases to the number of businesses seeking to become employee-owned, as a sale to an EOT for the benefit of the company’s staff can be much more straightforward.
