EOTs and CGT Relief - selling to an EOT NOW EVEN MORE COMPELLING
When the Employee Ownership Trust (EOT) structure was established in the Finance Act 2014, the headline incentive for vendors to sell to an EOT rather than to a third party was full capital gains tax (CGT) relief on the value of the shares sold to the trust. The vendor had to sell a controlling interest and comply with several other not difficult to meet requirements to take advantage of the CGT relief. For third party sale transactions, up until the presentation of the Chancellor’s Budget Speech on 11 March 2020, the Entrepreneurs’ Relief (ER) capital gains tax rate of 10% would otherwise apply to the sale proceeds. The 10% rate was applicable up to the vendor’s lifetime allowance of £10m in capital gains. If both spouses were shareholders and sold their shares, the lifetime allowance would effectively double to £20m.
For a business owner selling their company to a third party for £5m, the capital gains tax due on the sale would have been £500,000, assuming a cost basis of nil in the shares being sold. With a cost basis of nil, the entire amount of the sale proceeds would be viewed as a capital gain and taxed accordingly. If a vendor sold to an EOT at fair market value, the CGT relief, or the additional sale proceeds to the vendor, would be equal to the amount of the ER capital gains tax that would have otherwise been paid, namely £500,000. As you can see, there is a significant benefit to the CGT relief available under the EOT structure.
In his Budget Speech, the Chancellor has reduced the lifetime ER allowance to £1m from the previous £10m. This will have a significant impact on the net proceeds to a vendor selling their company in a third party sale transaction. Where the CGT under our previous scenario would have been £500,000, it is now £900,000, an increase of £400,000. This new tax amount is calculated by taxing the first £1m of sale proceeds at the ER rate of 10% (£100,000) and the remaining £4m at the full CGT tax rate for a higher rate taxpayer of 20% (£800,000) for a total of £900,000 in CGT. The change in the ER lifetime allowance almost doubles the potential CGT to vendors selling their business to a third party.
The difference in proceeds to the vendor is significant. If the vendor sells to an EOT at the same fair market value of £5m, the CGT relief amount, or additional sale proceeds to the vendor, would now be worth £900,000. This provides an even greater incentive for vendors to consider selling to their employees using the EOT structure.
From our perspective, vendors looking to sell their business owe it to themselves to at least consider selling to an EOT rather than pursuing a third party sale. While there are certainly reasons a third party sale can continue to make sense, business owners looking to transition are doing themselves a major disservice if they do not at least explore the EOT alternative.
The articles published on this website, current at the date of publication, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your own circumstances should always be sought separately before taking any action.