The EOT – using the legislation to achieve the best outcomes

 

Graeme Nuttall OBE is dual qualified as a solicitor and chartered tax adviser, and is a partner in international law firm Fieldfisher.  He served as government adviser on employee ownership with the Coalition Government, which commissioned and supported the landmark report the Nuttall Review, which set up the road map on how to get employee ownership into the mainstream of UK business. The introduction of the Employee Ownership Trust (EOT) in 2014 is a result of the findings of the Nuttall review and has led to a 300% increase in the number of UK employee-owned businesses. The Nuttall Review demonstrated that employee ownership delivers better business outcomes and improves employee well-being.

The EOT brings significant tax benefits both to the company owners who sell their business to an EOT, and to the employees in companies where a majority of the shares are held by the EOT.  If the company’s shareholders sell a controlling interest in the company to the EOT, then the transaction is exempt from Capital Gains Tax, a saving of up to 28%.  When the company is profitable, employees can benefit from a tax-free bonus subject to an annual threshold of £3600.

Uptake has accelerated in recent years, with a further 30 Scottish companies predicted to become employee-owned in 2021. Graeme congratulated CDS on their efforts and praised Scotland’s record in increasing the number of employee-owned businesses headquartered here.

Graeme’s presentation focused on the following key points:

• The EOT is more than a financial benefit for employees. 
• Employee ownership is far more effective when there is also employee voice and involvement, with employees having a real say in the company’s direction and goals.
• Advisers must consider the purpose of the Trust, and not regard it simply as a tax effective exit strategy.
• The EOT is intended to provide long-term employee ownership and all the planning and design decisions taken during the transaction need to be based around this purpose.

Graeme explained how the EOT was being adopted internationally, with countries such as Australia, Canada, Denmark and the US seeing a growing interest. The tax regimes in some countries made implementation of an EOT structure a challenge, but there appears to be a growing appetite to find a means to make it possible. This is largely down to the success of employee ownership in delivering benefits not only to the business, but to the wider economy.

Graeme is proposing some changes to the legislation to enhance employee voice and engagement, and limit any potential abuse. He would like to see a ruling that EOTs cannot be off-shored, and that there are strict guidelines in place about who can be in control of the Trust. He is requesting that there is a requirement for the EOT to be viewed as a vehicle for long term employee ownership. Graeme welcomed the Scottish government’s ambition of 500 Scottish employee-owned businesses by 2030, and urged that focus is on quality, not quantity.  The engagement and economic benefits are delivered when the EOT is in place for the right reasons.

Questions and Answers

Q: I’m interested in how the quality of new EOTs particularly around employee engagement can be supported, balanced with the aspiration to have 500 Scottish EOTs.
A: There is a lot of responsibility on advisors to ensure their clients see this as a business model in its fullest sense. It is not for advisors to create an employee ownership culture within companies, but they can influence implementation by asking the right questions to put the company in the employees’ hands. Luckily, in Scotland there are many advisors who understand that the creation of an EOT is more than a tax effective exit; it’s a structure that centres employee engagement and voice. I believe the 500 target set by the Scottish Government is ambitious and while I wholeheartedly support that ambition I would urge the focus to be on quality and not solely on quantity.

Q: Can you please throw some light on the financing structures of EOTs in the UK ?
A: The purchase price is generally funded by gifts to the Trust from the trading company. If the transaction requires the sellers to realise more value sooner, then the company can take on debt to finance some of the purchase price. Obviously the trading company needs to manage its cash flows and retain, for example, sufficient working capital.

Q: The point was emphasised about having an effective Trust Board. It is getting difficult to find knowledgeable Independent Trustees. Any thoughts?
A: It is critical that the Trustee Board is aware of its duties and responsibilities. The Independent Trustee has an important role and I agree it’s not an easy role to fill. We are seeing specialist recruiters enter this space. I believe we should also be looking at employees who have held this position. They will have gathered useful skills and experience and might make for excellent Independent Trustees with other businesses.

Q: How would you advise the Scottish Government in making a step change in the number of employee owned companies?
A: In order to implement employee ownership on a wider scale it needs the government behind it, but this doesn’t necessarily mean more regulations. Awareness is critical and CDS do a superb job with events like this and all of their other activities in getting the message out and supporting businesses through the process.

Q: Do you think professional institutes could do more?
A: All professional institutes should include employee ownership structures in their remit. Employee ownership should be part of the normal repertoire for anyone discussing business, much like franchising is. It was good to see that the Chartered Institute of Taxation has recently made a submission to the Government on EOTs.

Q: Do you see examples of employee ownership done well across the globe?
A: No one feels it’s being done as well as it should be. Even in America, were ESOPs are relatively well-known, everyone feels they’re underperforming. In terms of relative numbers Scotland and London are doing very well.

Q: Is there any thought that the proliferation of EOT transactions and the reduction in CGT take may lead to the Treasury reconsidering the tax reliefs – particularly if CGT rates on other transactions increased?
A: This is not an easy question to answer. There is general cross party political support for wider employee ownership in business. The Capital Gains Tax exemption on deferred payments, over what is typically a long period, is key to creating EOTs in the UK and in turn this creates jobs, helping with income equality, higher productivity levels and more engagement in the workforce. Also, although the number of employee-owned companies is growing, it is still a very small proportion of all companies.. I believe there are very strong grounds to continue the tax exemptions both in terms of the practicalities of implementing EOT buy-outs and achieving wider macro-economic benefits. Of course, we are in unpredictable times and no one can be certain what the UK Government might do in future.