EOTs – avoiding the tax avoiders

RM2 was interested to read about the views of the Chartered Institute of Taxation (CIOT) on the use of Employee Ownership Trusts (EOTs) as vehicles for tax avoidance in their pre-budget submission, as reported in The ESOP Centre’s newspad. 

CIOT have suggested that EOTs are, in some cases, being advanced purely as a tax-saving solution for business owners who can sell their company to an EOT, and pay no capital gains tax, without any genuine intention for the company to be owned and ultimately controlled by its employees.

It is a fact of life that where there is a tax saving to be had, advisers and business owners will do their best to obtain that tax saving, and in RM2’s view it has always been inevitable that the generous tax breaks attaching to EOTs would eventually attract some less scrupulous individuals with little or no interest in the concept of employee ownership.  It would however be tragic if the concept of the EOT was negatively impacted or watered down because of this, just at the time when the EOT is starting to become recognized as a genuine solution to ownership succession for private companies. 

Having said this, we consider that the newspad reporting of CIOT’s views paints a slightly sensationalised picture. In RM2’s experience – both in terms of potential clients who approach us, and our knowledge of transactions carried out by other advisers – the vast majority of EOT transactions are not carried out for tax avoidance purposes but rather with the intention of delivering a succession solution for exiting business owners alongside the transfer of company ownership to employees. 

In respect of CIOT’s comments, we entirely concur with their view that EOTs should not be based offshore (as is the case for Share Incentive Plan trusts).  None of RM2’s established EOTs have been set up offshore – nor, in fact, have any of our clients requested this.  We would never encourage our clients to set up an offshore EOT, if only for the sake of poor optics associated with such a move.

We also agree strongly with CIOT’s view that the majority of trustees should not be connected with vendors – although we note that, should legislation be amended in this regard, care should be taken not to be over-prescriptive in respect of corporate governance for smaller private companies. 

In respect of tax clearances – we don’t disagree that removing the requirement to get a tax clearance from HMRC might be helpful.  This is where a review of the legislation would be welcomed in order to clarify the position relating to the tax treatment of contributions from the establishing company.

Finally, we would add a further point relating to the potential clawback of capital gains tax relief should the EOT cease to qualify.  Currently, after a relatively short period, this risk falls on the trustees – and thus, ultimately, on the employees; to us, this is fundamentally problematic. 

Furthermore, there is no time limit relating to that risk of clawback – certainly, there should be some consequences should the trust become non-compliant within a short time, but to extend that period indefinitely seems unfair.  One consideration might be to taper the potential tax charge so that the risk eventually falls away altogether – a maximum ten year period would seem appropriate. 

We are not particularly fans of tinkering with legislation where it’s unnecessary and we all know that tax specialists can find loopholes and missing bits in the law if they search hard enough (and are paid sufficiently). However, we are inclined to agree that the legislation, that has now been in place for over 5 years, has now been tested reasonably fully, and some improvements and additions might be considered. 

If you’re (genuinely!)  looking to sell your company to your employees, RM2 would be happy to discuss the details with you.  Please contact us at enquiries@rm2.co.uk or on 0208 949 5522 where we can set up a call for an initial discussion.