Changes ahead for Employee Ownership Trusts and Employee Benefit Trusts

Supporting and encouraging employee ownership in a business can be achieved through the use of employee trusts, and a current government consultation is looking to maintain this objective.

The use of such trusts face various changes, including former owners of businesses sold to them being prevented from retaining control, as well as a requirement that trustees must be UK resident.

No date has yet been set for these proposed changes and a final version of the proposals will follow on from a consultation which ends on 25 September 2023.

This article looks at employee trusts, their use and what changes may lay ahead.

What are EBTs and EOTs?

• EBT – An Employee Benefit Trust is a trust set up to benefit employees or office holders of companies/ groups. Their purpose varies on the objective sought, but they usually enable the reward of key employees through share ownership or to administer benefits such as health cover.


• EOT – An Employee Ownership Trust is a type of EBT under the control of the Trustees for the benefit of all employees. This gives employees an effective ‘stake’ in the company that they work for. EOTs have favourable tax treatment including 100% capital gains tax relief for departing shareholders on the sale of shares to an EOT (provided certain conditions are met and maintained), as well as annual income tax-free bonus payments of up to £3,600 per employee. There is no Inheritance Tax charge on the transfer of shares to an EOT. The EOT itself is also exempt from Inheritance Tax.

Who might be affected?

• Business owners looking to sell to an EOT - The proposed reforms will explicitly exclude those who continue as directors from income tax-free bonus payments as well as providing clarity on the tax treatment of deferred consideration payments in legislation.


• Employees - Employees acting as trustees will benefit from greater control over the EOT if these proposals are enacted.


• Trustees - There will be stricter criteria on who can be a trustee of the EOT, this also applies to directors of a corporate trustee board.

When might these changes come into effect?

Whilst it is not yet known when these proposed changes may be enacted into legislation, it is important to be aware and prepare.

What are the proposed changes?

Employee Ownership Trusts

Summary of key proposed changes:

1. Trustee Appointment – Former owners will be prevented from retaining control
2. Trustee Tax Residency – Will need to be UK resident (currently trustees can be based overseas)
3. Issues of Funding the EOT and Clearances – Including removing the need to apply for clearance to ensure deferred consideration distributions to shareholders are not liable to income tax by confirming in legislation, as well as stopping clearances in respect of the application of section 464A to company contributions to EOTs where a company makes a payment to the EOT that is not a loan or advance.
4. Income Tax Bonus Issues – Making bonus payments easier to administer by awarding bonuses to employees without having to include directors

More detail on these proposed reforms is provided below:

1.    Trustee Appointment

There are currently no conditions for trustee appointments when EOTs are set up. This can mean that former shareholders can be appointed as trustees of the Trust board to retain some involvement in the operation of the company. Whilst the conditions state that this must be for the benefit of ‘all employees’, in reality this is difficult to police and enforce.

The consultation seeks to counter former shareholders retaining control and proposes requiring that 51% of the trustees of the EOT cannot be former owners, or persons connected with them. A breach of this condition would lead to a disqualifying event and consequentially, a capital gains tax charge will be levied on the former shareholder within the first year following disposal of shares to the EOT, and thereafter the charge will be levied on the trustees.

For situations where a corporate trustee controls the EOT, the proposed change will mean that former owners or connected persons with them (broadly spouses/civil partners and close relatives) cannot have control of the corporate trustee. 

2.    Trustee Tax Residency

Currently there are no obligations for EOT trustees to be UK resident, nor does the trust itself need to be UK resident. This means trustees of a non-UK resident EOT would not be liable to Capital Gains Tax on the occurrence of a disqualifying event (deemed disposal), nor on any disposal of shares of the target company. 

The government proposes that it will no longer be possible to establish a qualifying EOT that is non-UK resident for tax purposes. However, there is still scope within the rules to appoint non-UK resident trustees, so long as there is a mix of UK resident and non-UK resident trustees. 

The proposal introduces a requirement for either all trustees of the EOT to be UK resident or that the trustees are both UK resident and non-UK resident and that the former owner was UK resident or domiciled at the date the shares were disposed of to the EOT. 

Breaching this condition and turning a UK-resident EOT to a non-UK resident EOT would result in a Capital Gains Tax ‘exit charge’. The charge applies at any time after the disposal that sees the EOT become non-UK resident.

3.    Issues of Funding the EOT and Clearances

Advance clearance is typically sought where contributions are made to departing shareholders for their shares where the EOT does not have funds to pay the entire consideration upfront.

Therefore, such payments to departing shareholders tend to be funded through the distribution of profits paid to the trustees. Clearance is sought to ensure these payments are not to be treated as income distributions in the hands of the shareholders, and therefore income tax should not apply.

The consultation proposes removing the need to apply for clearance to ensure deferred consideration distributions to shareholders is not liable to income tax, by confirming it in the legislation instead.

In addition, where the company makes a payment to the EOT which is not a loan or advance, it is common practice to seek clearance from HMRC to ensure that the targeted anti-avoidance rules that look to counter tax avoidance arrangements do not apply to that payment.

The proposed changes intend to stop providing clearances in respect of the application of section 464A to company contributions to EOTs where a company makes a payment to the EOT that is not a loan or advance. Instead, so long as tax avoidance is not present, the targeted anti-avoidance rule (section 464A Corporation Tax Act 2010) will not apply.

4.    Income Tax Bonus Issues

Rules currently governing income tax-free bonus payments of up to £3,600 per employee per year are strict in the requirements that must be met in order for the payment to qualify for relief. These are:

• The participation requirement – broadly, all employees must be eligible to participate in the bonus
• The equality requirement – all employees participating in the bonus must have the same terms, the only variable factors to differentiate between employees are remuneration, length of service and hours worked. However, this cannot result in unfavourable weighting towards highly paid employees, directors or former directors; and
• The office holder requirement – bonus payments cannot be made if the number of directors (and employees connected with them) exceed 2/5 of the total number of employees.

This proposal intends to amend the qualifying bonus payment rules so that tax-free bonuses can be awarded to employees without the need to include directors. 

This means the tax-free bonus will be easier to administer. However, diligence will still be needed to ensure that the bonus payments are not weighted in favour of highly paid employees and directors.

Employee Benefit Trusts

Summary of key proposed changes:

Reforms to counter individuals connected to a participator from benefitting for the lifetime of the EBT to prevent: 

• Inheritance tax avoidance with no or very little capital distribution to the wider employee group; and
• Individuals connected with a participator benefitting from income distributions where they are excluded from benefitting from the capital of the trust.
• No more than 25% of employees who can benefit from income payments under an EBT are connected to the participator, for the EBT to benefit from favourable IHT treatment.

Any questions on the changes outlined in the consultation?

Please do get in touch if you have any questions relating to the proposed changes to the tax treatment of EOTs and EBTs outlined above, our expert team is on hand to assist.

If you would like to discuss how an EOT could work for your company, please contact a member of our tax team.