POPULARITY IS ON THE UP!

Employee ownership of companies (or employees owning some shares in the company) is becoming increasingly popular. Here we look at some ways in which this can be achieved.

Clive Haworth Senior Manager clive.haworth@etctax.co.uk

Employee Ownership Trust (EOT)

By far, the most popular method of transferring ownership of companies is through an EOT.

The attraction for the existing shareholders is that provided certain conditions are met, the sale of shares to the EOT is tax-free.

The main conditions to be satisfied are that the company must be a trading company, and the shares acquired by the EOT must be a controlling interest acquired from individuals.

In a typical scenario, the purchase price of the shares by the EOT will be funded over a period of time – the company will gift money to the EOT to fund these payments.

Once the EOT is in place, the employees may receive bonuses of up to £3,600 per year free of income tax (but not NIC), provided bonuses are calculated in line with equality requirements.

The EOT must be for the benefit of all employees on the same terms, and to qualify for the tax-free treatment, the EOT must hold the shares until the end of the tax year, after which the individual sold their shares.

HMRC Clearance

It is usual to seek clearance from HMRC that the company and EOT meet the qualifying conditions. In addition, it is essential to determine that the share sale price is at arm’s length – any excess is subject to income tax on the shareholder.

Future disposal of shares by the EOT

If the company is subsequently sold, the EOT will pay 20% capital gains tax on its gain on the shares it holds, but this effectively means the CGT liability that the shareholder would have paid (had there been no disposal to the EOT) is passed on to the trust.

Share Schemes

It is not unusual for a tax-advantaged share scheme to be run alongside an EOT. This is usually for the senior management team to enable them to acquire shares personally. This does not impact the EOT itself, provided its shareholding remains a controlling interest. The most popular scheme is the Enterprise Management Incentive (EMI) scheme, as growth in value of the shares from the date of grant to the date of exercise is currently subject to more favourable CGT rates rather than income tax rates. Business Asset Disposal Relief (BADR) is also available, so net gains up to £1m are taxed at 10% rather than 20%. Growth share schemes are also popular. The shares given to employees only participate in future growth in the company's value, so the initial value can usually be agreed upon at par value with HMRC. Again capital gains on the sale of the shares are taxed at CGT rates rather than income tax rates. However, BADR will not be available.

Company Purchase of Own Shares

In some circumstances, the company can buy out the majority shareholder leaving other shareholders (which can include employees) in control of the company. Care should be taken in structuring such a transaction correctly to avoid adverse tax consequences.