Employer Ownership in the UK and US: Employee stock ownership plans and employee ownership trusts
Employer Ownership in the UK and US: Employee stock ownership plans and employee ownership trusts
As business owners’ inch closer to retirement, the decision about what should happen to their business, and to some degree their legacy as a business owner, becomes more pressing.
While many options exist, one strategy that has seen an increase in global popularity is selling a majority or minority stake in the business to the employees of the company. As outlined below, there are substantial tax incentives associated with such a sale both in the UK and the US.
Selling to your employees: UK and US approaches
The UK and the U.S have some of the most favourable tax laws relating to employee ownership. There has never been a better time for directors and shareholders to sell a business to its employees.
The Employee Ownership Trust (EOT) in the UK and the Employee Stock Ownership Plan (ESOP) in the U.S. are true employee ownership models, in that the company is sold to the employees through a trust for the benefit of the current and future employees of the firm.
Employee ownership across borders
When a multinational company based in either the UK or the U.S. decides to transfer ownership to employees, one challenge that may arise is that other countries do not offer the same tax benefits of employee ownership.
For instance, if a U.S. company sells to an ESOP but has operations in Canada, France, Italy, Spain or the United Kingdom, employees in those countries may participate in the ESOP but would have to pay taxes on the allocated shares. It would not make sense to include those employees in the ESOP plan, but they may participate in a benefit plan that mirrors the benefits other employees receive from the ESOP. These plans can take various forms, whether it be through a management incentive plan, phantom shares or a defined benefit plan.
Benefits of employee ownership
The key benefits of an EOT or an ESOP are that they create an immediate purchaser for the company, they address succession issues that can be a real challenge for family-owned businesses, and they allow employees to take a more active and constructive interest in the company. Research in both countries has found that when the employees are a company’s greatest assets, the employee-ownership model can be the “go to” model for a corporate sale as it offers greater employee engagement and commitment, greater drive for innovation and improved business performance. Read more on incentive plans for employee-owned companies here.
Tax advantages of employee ownership
The UK and US governments have continued to add various tax breaks for both sellers and the operating company in both EOT and ESOP models.
In the UK, the government supports the idea of employee ownership and has offered substantial tax exemptions to shareholders and employees that move to the model. UK tax resident shareholders can sell their shares in a qualifying trading company for full market value and claim a full statutory capital gains tax exemption so that they receive the full gross disposal proceeds. In addition, any company that is controlled by the trustee of an EOT can make tax-free bonus payments of up to £3,600 per employee per annum.
In the US, a selling shareholder of a C Corporation ESOP can defer capital gains if proceeds are invested in a certain way. The key difference in tax law relates to the operating entity and the applicable tax deductions. In the UK, the trading company is not able to claim a corporation tax deduction for any payments that it makes to the EOT (which will be used by the EOT trustee to pay the former shareholders their deferred disposal proceeds) on the basis that the payments are deemed to be capital rather than revenue in nature. An ESOP in the US can take tax deductions based on the total eligible payroll. If the operating company is an S Corporation and a company sells 100% to an ESOP, it can be fully exempt from federal and most state income taxes.
The ESOP may be the most well-known employee ownership vehicle in the U.S., but the EOT model is also possible in the U.S. through a perpetual trust. The tax advantages are not yet as great as those related to an ESOP sale, but there are efforts in motion to ensure that the EOT model in the U.S. has similar tax benefits as the UK EOT model.
Employee Ownership Trust vs. Employee Stock Ownership Plan
The key difference between the EOT and the ESOP model is that in an ESOP, the employees receive beneficial shares in individual retirement accounts and when they leave the company or retire, they receive payment from the company for the value of those shares. Under the EOT model, the employees do not receive actual shares; instead, the trustee of the EOT holds the shares for and on behalf of all employees in the company.
Another stark difference between the ESOP and EOT model relates to a minority sale of a business. An EOT must have a controlling interest in the company, whereas an owner can sell a minority interest to an ESOP.
In both models, if the company is sold, the employees share in the proceeds from the sale.
If the trustee of the EOT sells the company to a third party, and the former shareholders receive all their proceeds from the transaction, any excess proceeds would be divided amongst the employees after any capital gains tax liability has been paid. The sales proceeds can be split equally between all group employees, or the trustee of the EOT can divide the proceeds between the group employees based on one or more of the following three criteria: (i) length of service; (ii) hours worked; and / or (iii) levels of remuneration. Most companies that are sold to an EOT put in place new, tax-efficient share plans to lock-in, incentivise and reward key management post-disposal of the company to the EOT.
In contrast, an ESOP allocates proceeds based on vested shares. A powerful example of this was the sale of New Belgium Brewing, headquartered in Fort Collins, Colorado. New Belgium was 100% ESOP-owned and was sold to Lion Little World Beverages in Australia for $190 million, which was split among employees based on their total vested shares in the ESOP plan.
The below table compares the two employee ownership models:
Your next steps
Are you considering moving to an employee-owned model?
We work on both sides of the Atlantic, advising shareholders through the entire sale process, and can ensure that your benefit plans and tax strategies align across a global business.
If you have any questions about EOT or ESOP, please get in touch – our team of specialists will be happy to help you.