Lee Sharpe looks at one of the most underrated tax-saving arrangements for the business.
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In tax terms, trusts have largely been poorly served, going back at least as far as the ‘reforms’ of April 2006 (and arguably years before then); which is strange, because they are commonplace and widely seen in pensions, life insurance products and property arrangements, for example.
It is probably fair to say that we typically settle on a trust vehicle these days in spite of the tax consequences, rather than because of them. A new government-approved trust vehicle that saves tax is a rare thing indeed.
Employee ownership trusts
The special tax regime for employee ownership trusts (EOTs) was introduced by Finance Act 2014 (FA 2014, s 290, Sch 37), offering an alternative to a third-party sale, or a more traditional management buyout. Broadly, EOTs comprise a sub-set of employee benefit trusts (EBTs) that have something of a chequered past, thanks in no small part to the notoriety of the ‘Rangers case’ (RFC 2012 Plc (in liquidation) (formerly Rangers Football Club) v Advocate General for Scotland [2017] UKSC 45). But the coalition government wanted to favour employee participation or shareholding as a means of encouraging economic growth, following the Nuttall Review published in July 2012.
The John Lewis Partnership is perhaps the best-known (and certainly the largest) firm owned by its employees, or ‘partners’. But it was created almost a century before EOTs were promoted. Richer Sounds, the audio-visual retailer, is one of the higher-profile businesses to have officially gone down the new EOT route, in 2019; the Entertainer toyshop chain announced its own transition, mid-2025.
Main tax features
The key tax incentives are as follows:
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The ‘original vendor’ gets 100% capital gains tax (CGT) relief on a qualifying disposal of their trading company shares to the EOT, in the tax year that the EOT first secures control of the company. The sale should also be free of income tax or inheritance tax (IHT) consequences.
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The employees can each be paid up to £3,600 a year, free of income tax (but still subject to National Insurance contributions).
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Unlike most trusts, the trust assets (predominantly the target company’s shares) can carry on IHT-free in the trust – no ten-year anniversary charges or exit charges.
Main conditions
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The company must be either trading or the holding company of a trading group (some modest non-trading activity is permitted, however).
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All employees must be eligible to benefit from the shares in the trust, although eligibility may be adjusted according to:
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remuneration level;
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length of service; and
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hours worked.
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The employee ownership trust must end up controlling the company by the end of the tax year of the transfer. Even so, the vendor does not have to sell 100% of the share capital; for example, in the case of Richer Sounds, the owner sold just 60% of the company shares to the EOT. The vendor or their family may therefore retain a very substantial stake in the company.
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But the number of original shareholders who continue to hold shares (and any 5%+ shareholders, directors or employees associated with them) cannot exceed 40% of the total number of employees of the company (or group). If the original vendor wants to keep numerous family members as shareholders, a larger employee base is required to exceed the minimum fraction.
Following a review in 2023, Finance Act 2025 introduced several adjustments, including:
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To retain the CGT relief on selling the shares to the EOT, the ‘probationary period’ during which the conditions must be met has been extended from one year to four years after the tax year of sale.
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Trustees will need to be UK resident (not just at the point of setting up the EOT).
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The EOT must be and remain independent of the original vendor shareholders – they cannot control the trust or make up more than 50% of the trustees.
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The trustees must ensure that the consideration paid for the shares does not exceed market value (although it can still be less, depending on the generosity of the original vendor); nor that any interest paid for consideration left on loan exceeds a commercial rate of return for the vendors.
Financing the transaction
The company will usually contribute some of its cash reserves to allow the EOT to pay for the shares at least partly in cash although the company will often be unable to fund the full consideration – instead, the EOT may borrow from banks, or more likely the proceeds will be left on loan using loan notes, repayable over time (i.e., as and when future profits allow).
Finance Act 2025 also now sets out a specific measure to put beyond doubt that dividends paid out to the EOT should not be taxable, to the extent they are used to fund its share acquisition costs (but note this applies to dividends funding the share sale to the EOT, not to all future dividends).
Sudden attraction?
Many small business owners struggle with a suitable ‘exit strategy’ if they are unable to find a willing buyer at the time they are minded to sell up. An EOT offers a reasonable alternative, where the owner is prepared for their family to forfeit outright control of the business going forward.
While the tax cost should not necessarily dictate the commercial solution, note that, by contrast:
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The CGT business asset disposal relief (BADR) cumulative lifetime limit was cut from £10m down to just £1m for disposals on or after 11 March 2020. Furthermore, BADR relief will offer only a 6% marginal saving (18% against the standard 24%), for disposals on or after 6 April 2026.
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We now have a similar £1m limit to combined IHT agricultural property relief (APR) and business property relief (BPR) at the full 100% rate (50% applies for transfers exceeding the new limit) from 6 April 2026.
CGT – There is no cap on the CGT relief available when transferring the shares to an EOT, and the shares can be sold for their full market value as if to a third-party buyer. So, for an owner-managed company worth several £m, an EOT solution might be significantly more CGT-efficient than a simple sale with BADR, while not necessarily forcing the vendors to make significant compromises on the asking price.
IHT – In terms of IHT planning, the immediate relief is helpful inasmuch as it does not impede the EOT route. The ongoing or future special IHT relief would be of little interest to the vendor family in an outright sale. But restricting the availability of 100% BPR on death arguably ‘encourages’ business owners to try something other than simply relying on unlimited BPR to allow them to leave everything to the children to sort out, on the business owner’s death (which is not to say that this would have been ‘wrong’; in many cases, this might well be perfectly acceptable planning). For a company of the right size, and where the owner is happy for their family not to control the company indefinitely, they might yet retain a good (say) 25% to 40% to leave to the children or grandchildren, but have passed over a qualifying controlling interest to the EOT.
Conclusion
The Employee Ownership Association states that there are now more than 2,200 employee-owned businesses in the UK and that growth is ‘exponential’ (although they will not all be EOTs). The tax-approved regime introduced in 2014 does seem to have helped move things along.
As an alternative to an outright sale, the EOT is very tax-efficient, but may take longer to secure proceeds in cash, as the business will typically fund at least some of the sale through future profits.
In terms of more traditional succession planning, the government may hope EOTs enjoy a further boost, once full BPR and APR can no longer be taken for granted. But that may also need people to break with the tradition of simply keeping it all in the family, from one generation to the next.
