MHA | Employee Ownership Trusts and the double taxation issue

Employee Ownership Trusts and the double taxation issue

Chris Blundell · February 15th 2024 · read

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HMRC has been consulting on, amongst other things, a requirement that the trustees of an Employee Ownership Trust must be UK resident for tax purposes.

For the trustees of an Employee Ownership Trust (EOT) to be UK resident, 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 or owners of the shares be UK resident or domiciled at the date the shares were sold to the EOT. A breach of this condition at any time after the disposal such that a UK-resident EOT becomes non-UK resident would result in a capital gains tax (CGT) ‘exit charge’. This would be a tax charge for which the trustees would have no cash with which to pay it, a “dry” tax charge, with the company having to fund it somehow. Also, forcing the EOT trustees to be and remain UK resident would result in double taxation when the EOT trustees came to sell on their company shares.

If the government do decide to prevent the trustees of an EOT being resident outside the UK, we would hope to see measures introduced in the Spring Budget on 6 March that eliminate the issue of double taxation when a UK resident EOT comes to sell the company shares it owns. We would envisage these measures being similar to the concessionary measures that exist if a company pays a dividend to an EOT trustee, which is then paid on to employees.

The issue of double taxation

Currently, tax legislation means that when a UK resident EOT sells a company’s shares, it will have to pay CGT at 20% on its gain.

The EOT’s gain will in most cases by pretty much the whole of the sale proceeds from the shares. The issue arises when the EOT trustees pay the net proceeds from the share sale on to the employees who are beneficiaries of the EOT. When that happens, the employees will need to pay income tax and NIC on the whole of the net proceeds paid to them at combined rates of up to 47%, whilst the employer will additionally have an Employer’s NIC bill of 13.8% on the sums paid to the employee beneficiaries. This results in double taxation for which there is no relief currently.

To prevent this double taxation, many companies setting up EOT’s have chosen to locate them outside the UK in a location like Jersey or Guernsey.

To take an example, if a UK based trust decides to sell on the company, it will be due to pay CGT on the gain it makes on sale. When it distributes the net of tax proceeds to the employees, they are then due to pay employment income tax and NIC of up to 47% under PAYE on what they receive. Additionally, their employer will have a 13.8% employer's NIC liability on what is paid to the employees. This means that of £100 of proceeds only £37.25 will end up in the employee's hands after the additional Employer’s NIC bill of 13.8%, an effective tax rate of nearly 63%.

Unlike with dividends, where trustees of an EOT pay the net proceeds out to the employee beneficiaries, they can’t reclaim any of the CGT they have had to pay. If a requirement is introduced in the 6th March Budget, this will need to change if EOTs are to continue to be used to pass businesses on to their employees.

HMRC consultation

HMRC’s consultation document issued in July 2023, proposed measures to prevent the trustees of an EOT being resident outside the UK, meaning they will always be liable to 20% CGT were they to sell on the company’s shares they own.

This was a change put forward by, amongst others by the Chartered Institute of Tax and is to stop EOTs from avoiding the CGT the drafters of the EOT legislation expected would be paid when the EOT sold on the company to a third-party buyer. In such a situation, if UK resident, EOT’s would pay CGT on not only their own gain but also the gain inherited from the original sellers of the shares to the EOT.

Spring Budget 2024 expectations for Employee Ownership Trusts

If the government introduce a measure requiring that the trustees of an EOT be UK resident, we would urge the government to look at measures to resolve this issue of double taxation. Even if they do not introduce such a residency requirement for the trustees, we would still urge the government to look at this double taxation issue so that EOT trustees are not forced to consider basing themselves outside the UK. The EOT has become a valuable vehicle which allows companies to be sold into the indirect ownership of their employees. It has become increasingly popular since it was introduced in 2014 particularly with the opportunities that it gives for owners to sell their shares to the EOT without having to pay CGT, and employers to pay income tax free bonuses of up to £3,600 per employee per tax year.

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If the government introduce a measure requiring that the trustees of an EOT be UK resident, we would urge the government to look at measures to resolve this issue of double taxation.

Human Capital Advisory Partner - MHA Chris Blundell

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