Consultation to close EOT and EBT loopholes

The government is consulting on measures to change the rules for two types of employee trusts: Employee Benefit Trusts (EBTs) and Employee Ownership Trusts (EOTs). The proposals are not particularly controversial, perhaps the real question is, why it has taken so long to make some of the proposed changes.

This is a freeview guide.

• Individuals who dispose of a controlling interest in their trading company to an Employee Ownership Trust (EOT) benefit from 100% Capital Gains Tax (CGT) relief on the disposal.
• Income Tax relief is also available on receipt of a qualifying bonus of up to £3,600 per year per employee of the EOT-owned company.
• An Employee Benefit Trust (EBT) is a trust which is set up by an employer to reward and motivate employees. The employer can use it to provide any type of benefits e.g. pensions and bonuses or it can be used to purchase shares from leavers etc. Benefits provided may be pensions, sick pay, a share of profits, shares or almost anything the employer chooses.
• It's a condition that trustees of the EBT must apply the trust property for the benefit of all the eligible employees of the company or group of companies.
• When qualifying conditions are all met, there is also no Inheritance Tax (IHT) charge on the transfers to EOTs and EBT and they are exempt from the Inheritance Tax relevant property regime. 

Buy-out by EOT is a highly popular model for employee ownership in the UK. The Employee Ownership Association estimates that over 1,000 companies have now transitioned to employee ownership. After ten years of this model, the government is now concerned that the legislation requires modification to ensure that reliefs available when adopting the EOT model operate as intended.

HMRC has been engaged in litigation to prevent EBTs from being used in abusive tax avoidance schemes for the last thirty-plus years and government is still keen that EBTs should continue to be used to provide employee benefits.

The new consultation makes the following proposals:

EOTs

1. Ensuring that ex-owners cannot control the board of trustees

A key feature of a buy-out by an EOT is that the company owner transfers control of their company to employees via a trust. However, when company owners set up the EOT they are free to appoint the trustees. Currently, there is nothing to prevent the former owners from appointing themselves (or their associates) as the sole or majority trustees of the EOT thus allowing them to retain control of the company through their control of the trustee board.

• The government now proposes a change in the rules to ensure that the former owners (alone or when taken with persons connected to them) do not constitute a majority of the trustees.
• A breach of these proposed conditions after disposal would be a disqualifying event and lead to an immediate Capital Gains Tax charge to the trustees (or to the former owner, if within the first year following disposal).

2. Ensuring that ex-owners cannot control the EOT via a corporate body

Consideration is also needed for EOTs that are controlled by a corporate trustee, to ensure that former owners or connected persons could not retain control of the EOT via control of that corporate body.

• The government proposes to define ‘connected persons’ using the existing definition found at section 286(2) of the Taxation of Chargeable Gains Act 1992. This includes spouses/civil partners and close relatives of the former owners.

A breach of these proposed conditions after disposal would be a disqualifying event and lead to an immediate Capital Gains Tax charge to the trustees (or to the former owner, if within the first year following disposal).

Further views are being canvassed on whether conditions on EOT trustee appointments should be defined further, for example, to require that one or more trustees be appointed or elected from defined groups such as employees of the company.

3. Ensuring that EOT trustees do not avoid later CGT by being non-resident

At present, there are no conditions in the rules regarding the residency status of EOT trustees. The result is that some owners use non-resident trusts to avoid CGT on a subsequent resale to a third party.

• The government proposes to introduce a requirement that the trustees of an EOT be UK resident as a single body of persons as defined at section 69 of the Taxation of Chargeable Gains Act 1992. This would require that either the trustees of the EOT all be UK resident; or that the trustees be a mix of 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.

A breach of this condition at any time after the disposal such that a UK-resident EOT becomes a non-UK resident would result in a Capital Gains Tax ‘exit charge’ under existing provisions at section 80.

4. Funding EOTs: correcting the distribution issue

It is common for most of the consideration due to the departing owners to remain outstanding at the point of sale. Any balance owed is then paid to the departing owners over a period of time and funded through distributions of the company's profits paid to the trustees.

In order to avoid the adverse effect of the distributions rules in s.1000 of the Corporation Tax Act 2010, company owners seek advance clearance from HMRC to confirm that HMRC will not seek to tax such contributions as distributions in the hands of the EOT trustees. HMRC has been 'happy' to play along with this and grant clearance despite the fact that most tax experts agree that these payments are actually taxable as distributions.

HMRC confirms that it will stand by any clearance given and accepts the uncertainties inherent in the current approach.

• The government proposes to confirm in legislation that contributions made by the company to the EOT trustees in order to repay the former owners for the acquisition cost of the company shares, will not be treated as distributions for the purposes of section 1000 or section 1020. This would include associated stamp duty and any interest payable at a reasonable commercial rate.
• This rule change comes with the additional rule, that this would only apply if the consideration paid by the trustees for the shares does not exceed the open market value for those shares. 

5. Funding for EOTs: confirming no s.464 charge

Where the company makes a payment to the EOT which is not a loan or advance there could be the potential for HMRC to apply the targeted anti-avoidance rule for arrangements conferring Benefit on Participators in s.464A CTA 2010. It has been a practice to apply to HMRC for advanced tax clearance that this will not apply.

• HMRC proposes to stop providing clearances in respect of the application of s464A to company contributions to EOTs. Provided a tax avoidance purpose is not present, s464A will not apply.

6. Changes to the £3,600 Income Tax-free bonus rules

The tax-free bonuses cannot be weighted in favour of directors or the highest-paid individuals in an EOT but no bonus can be paid if the number of directors or office holders and other employees connected with them when compared to the total number of employees exceeds a ratio of 2/5.

• The government is considering amending the qualifying bonus payment rules so that tax-free bonuses can be awarded to employees without directors necessarily also having to be included. These changes would make the tax-free bonus, a key incentive for the setting up of EOTs, easier to administer, and in turn make EOTs more attractive as a whole. Any changes would need to continue to ensure that the bonus payments cannot be weighted in favour of directors and the highest paid, or otherwise be exploited.

EBTs

7. Preventing participators from benefiting from EBT capital after the seller's death

The government want to ensure that genuine EBTS are set up to ensure that they are for the benefit of all or most employees and that participators (or anyone connected to them) may not benefit from the capital of the EBT at any time.

If an EBT meets the qualifying conditions for IHT, it will not be subject to ten-year and exit IHT charges and transfers into an EBT are exempt from IHT. Also, transfers into an EBT that meet conditions set out at section 28 will be exempt from IHT where there is a transfer of shares or securities in a company by an individual, a close company (section 13) and in relation to relevant property trusts (section 75).

A key condition is that participators (or anyone connected to them) may not benefit from capital of the EBT at any time, and the class of people who can benefit must include all or most employees

There are cases where the trust deed allows individuals connected to a participator to benefit after the participator’s death.

• The government now proposes making it explicit in legislation that the restrictions on connected persons benefitting from an EBT must apply for the lifetime of the trust.

9. Adding a two-year rule for IHT relief

Under the current rules, an individual can set up a company, immediately make a transfer of shares to an EBT and obtain the IHT exemption.

• The government proposes introducing a rule where the settlor needs to have held the shares for two years prior to settlement into an EBT in order to gain this exemption.

9. Ensuring that participators do not benefit from income

HMRC is concerned that EBTs are set up so that participators or their family members can benefit from income earned by the EBT under where EBTs are set up to meet the conditions set out in the Inheritance Tax Act 1984 but little or no capital is given to the wider class of employees.

• The government proposes introducing a provision that no more than 25% of employees who are able to benefit from income payments under an EBT can be connected to the participator in order for the EBT to benefit from favourable IHT treatment.

This consultation runs until a summary of the questions in this consultation is included below.

Responses should be sent by 25 September 2023, by email to This email address is being protected from spambots. You need JavaScript enabled to view it. 

Useful guides on this topic

Employee Ownership Trusts: An exit route for owner-managers
What is an Employee Ownership Trust (EOT)? When are they a good exit route for owner-managers? What are the tax benefits?

Close company loans to participators
What is the Corporation Tax treatment when a close company makes a loan to a participator (director-shareholder)? How do the 'bed and breakfasting' rules work? When are benefits taxed

EBT schemes: where are we now?
What is the current position with EBT schemes? How does the loan charge apply? What are the current settlement options?

External links

Consultation: taxation of EOTs and EBTs

Taxation of Employee Ownership Trusts and Employee Benefit Trusts

Consultation questions

Question 1: Do you have any comments on the proposal to prohibit former owners and connected persons from retaining control of an EOT-owned company post-sale by appointing themselves in control of the EOT trustee board?

Question 2: Should the government go further and require that the EOT trustee board includes persons drawn from specific groups, such as employees or independent persons? If so, how should these groups be defined?

Question 3: Do you have any comments on the proposal to require that the trustees of an EOT are UK resident as a single body of persons?

Question 4: Do you have any comments on the proposal to confirm in legislation the distributions treatment for contributions made by a company to an EOT to repay the former owners for their shares?

Question 5: Do you have any comments on the proposal that HMRC stops giving clearances on the application of section 464A of the Corporation Tax Act 2010 to the establishment of EOTs?

Question 6: Should the EOT bonus rules be eased so that tax-free bonuses can be awarded to employees without directors necessarily also having to be included, and would this undermine protections which ensure that bonus payments are not abused or weighted towards some employees?

Question 7: Do the EOT bonus rules create any other unintended consequences or challenges in administering the tax-free bonus payments?

Question 8: In addition to the reforms proposed at Chapters 4 to 6, do you have any views on ways the Employee Ownership Trust tax regimes could be reformed to better support employee ownership?

Question 9: Do you have comments on the proposal to confirm the government’s position by making it explicit in legislation that the restrictions on connected persons benefiting from EBT must apply for the lifetime of the trust?

Question 10: Do you have any comments on the proposal to only allow the IHT exemption where the shares have been held for two years prior to settlement into an EBT?

Question 11: Do you have any comments on the proposal that no more than 25% of employees who are able to receive income payments should be connected to the participator in order for the EBT to benefit from favourable tax treatment?

Question 12: In addition to the reforms proposed at Chapter 7, do you have any views on ways the tax treatment of EBTs could be enhanced?