With the passing of the Budget on 30 October 2024, there have been some changes to the regime governing EOTs – some of which reflect certain of the proposals made in the Governments consultation on the matter back in July 2023.
The Changes
The upshot of the Budget was that the 100% capital gains tax (CGT) relief on a qualifying disposal of shares to an EOT remains, meaning sellers can dispose of their shares in a company to a qualifying EOT on a tax-free basis. However, there has been some tightening of the rules around this, and the EOT regime generally, including:
- Former owners cannot retain “control” of the business, or the EOT, post-sale. This is the new “Trustee Independence Requirement” that will be met if less than 50% of the trustees of the EOT are made up of the sellers or persons connected with them. In practice, this should not result in much of a change going forward – it has always been prudent in the view of good governance to have the trustee board made of up a majority who are not sellers, and this now makes that a requirement. Failure to meet this requirement – subject to a few exceptions – could result in a disqualifying event (which we touch on further below).
- Contributions made by the target company to an EOT will not be taxed as distributions for income tax purposes. It is commonplace for the target company to contribute cash to the EOT to enable it to pay the sellers / costs relating to the acquisition, and there is now certainty over how these contributions are perceived from a tax perspective.
- The trustees of the EOT must be UK resident at the time of disposal.
- The share price paid cannot exceed the market value. To qualify for CGT relief, the trustees of the EOT must now take all reasonable steps to ensure that they have paid fair market value for the business, and that the rate of interest payable on any deferred consideration does not exceed a reasonable commercial rate. Again, it is commonplace for there to be an independent valuation of the target company – often through a feasibility study provided by Scottish Enterprise – to give the trustees some protection against this, but it will be interesting to know what will satisfy the requirement for “all reasonable steps”. It would seem that an independent valuation from an unconnected firm of accountants would be a good starting point though.
- The “Vendor Clawback Period” has been extended to four years. This relates to “disqualifying events” and the period in which the tax relief from CGT can be recovered from the seller if the qualifying conditions for the relief are breached. Previously, HMRC could only come after the sellers if the disqualifying event occurred in the year following the disposal, but this is now four years, which is a marked change although not unaligned with the expectation that any a sale to an EOT is for the long-term future of the business.
Concluding Remarks
As can be seen the changes made – which, in respect of those noted above, apply to disposals that take place on or after 30 October 2024 - have not materially altered the EOT landscape, and in some ways provide clarity, but will give food for thought for those considering and advising on EOTs. For now, though, we know that the headline CGT relief is still available and, with the uplift to CGT rates announced on 30 October, an exit to an EOT may seem more attractive than ever.
If you would like more information on these changes or the process of an exit to an EOT or, please contact Neil McWilliam on 03330 430350.
