The model of employee ownership has long been politically appealing as a supposedly more egalitarian alternative to more common business ownership models. The UK has a long history of employee ownership – John Lewis is a well known example – and the 2012 Nuttall Review championed the model, highlighting the economic benefits for companies which are employee owned.
Following on from the Nuttall Review, the UK Government introduced a new set of tax incentives known as employee ownership trusts (or EOTs) to encourage companies to convert to employee ownership. The main carrot was dangled in front of the current owners of businesses: a full or partial exit from the business with no capital gains tax for them to pay.
However, the position for employees is more mixed and raises the question of whether EOTs create true employee ownership, with the increased employee engagement that can bring. To see why, we need to delve into the mechanics of how EOTs work.
How do employee ownership trusts work?
- The business owners sell over 50% of the company's shares into a trust set up for the purpose of holding these shares on behalf of the employees.
- The purchase by the trust is typically funded by leaving the payment outstanding. This loan to the previous owners is then paid off over time using the profits of the company, which is tax-free for the owners.
- This sale is free of CGT for the owners, but the capital gain is simply deferred and becomes a future liability of the trust.
- The management team of the company will continue to run it on a day-to-day basis. The trustees effectively act as shareholders on behalf of the employees, but there is no requirement (yet) to have employee representation.
- The usual tax advantages of ownership – lower tax on dividends compared to salary, CGT on sale of the shares – do not apply to the employees. Instead, they pay income tax and National Insurance (NIC) on everything they receive, with one exception.
- The sole sweetener for employees is that they may receive a bonus of up to £3,600 per year free of income tax (but not NIC).
There are of course various requirements which must be met for these tax advantages to apply, such as the company being a trading company and the trust must treat all eligible employees equally (although not necessarily the same).
Who are employee ownership trusts for?
EOTs suit owners who are looking for a medium-term exit, who are attracted by the tax advantages now, whilst potentially remaining involved in the business. Obtaining third party finance can be difficult, so owners are more likely to be paid over several years from profits of the company rather than receiving a potentially lifechanging lump sum.
There are no particular downsides for the employees, but they may not truly feel like they own the business, with the advantages that can come with that. If employees do not have adequate representation amongst the trustees, they may not feel like they control the business at all.
Has the employee ownership trust model been successful?
The Nuttall Review identified barriers to companies converting to employee ownership. EOTs overcome some of these barriers, and has undoubtedly encouraged companies such as Richer Sounds, Go Ape and Riverford Organics to convert. But has it done so at the cost of true ownership by employees?
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