Employee Ownership Trusts: How to navigate the HMRC tax clearance process

From a tax perspective, the EOT tax clearance process is very important but relatively straight forward once the structure and EOT objective is clear. In our experience, HMRC typically approves these in 3-4  weeks (although, it can be up to 6 weeks) with clearance subject to the conditions being met. 

The more complicated and lengthy process is the discussions with management and employees and the setup of an EOT structure, which needs to take place well in advance of HMRC clearance application. 

Key things to agree on before the tax clearance application: 

What is the commercial purpose of an EOT? 

  • What proportion of the company’s shares will the EOT acquire? 51%, 100% or somewhere between, if you’re seeking capital gains tax exemption for the sellers? 
  • Who will be managing the EOT as Trustees? 
  • What is the value of shares to be sold? 
  • What is the market value of the company? 
  • How will the share purchase be funded? 
  • How many years will it take to repay? 

When thinking about these questions, don’t forget: 

  • An independent valuation report will help to establish the market value and avoid any tax complications on the sale of the shares for the shareholder
  • A robust financial model provides comfort that the business will be able to finance the purchase obligations entered into by the EOT
  • The EOT structure is crucial to avoid any personal liabilities falling on the trustees of the EOT.

For a tax clearance, the most important question is what is the primary motivation for the EOT? This is something the owners of the company and the advisors need to be clear about.

The lawyers and the accountants will be on hand to help with an independent valuation of the company, financial models, legal documentation and other supporting documentation. Still, the business owner needs to decide why they are doing this and how involved they would like to be in the business once the controlling interest is sold to an EOT. The driving reason for the EOT establishment will make or break an HMRC tax clearance application. 

What is the anti-avoidance provision that clearance is sought for, and why is it so important for an EOT? 

The anti-avoidance provision that applies here is called ‘transaction in securities’, and it potentially applies as the share sale by the shareholder(s) can be seen as a “disguised distribution”. Thus, getting clearance for an EOT transaction is important to ensure the provision doesn’t apply. 

Why is it important? 

It is important as it avoids any potential argument over the profit and loss account reserves, which could otherwise have been paid as a dividend.

For example, if a company with small retail shops has recently sold 9 out of 10 shops, and with the one remaining trading shop applied for clearance to sell shares to an EOT, it would probably not get clearance because the profit made on the sale of the shops could have been distributed as dividends rather than to finance an EOT, with an objective to get 0% CGT. HMRC could see this as an example of tax avoidance that has no main benefit for the company or its employees. 

The government encourages companies and their shareholders to consider setting up an EOT through the application of significant tax benefits. Still, with the risk of future CGT increase in rates, this will certainly attract speculative applications. That is why an advance clearance is recommended before setting up an EOT to ensure the success of the scheme and benefits of the tax reliefs. 

We always recommend that you seek advice from a suitably qualified adviser before taking any action. The information in this article only serves as a guide and no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or the firm.


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