EO Explained: EO Transaction Distributions

Continuing our series of articles explaining Employee Ownership (EO) our guest authors provide legal and tax clarity on transaction distributions post October 2024.

Distributions from companies owned by an Employee Ownership Trust (EOT) are a familiar feature of many EO structures. In practice, however, recent changes and ongoing misunderstandings mean distributions are an area where tax, legal and governance issues are increasingly being missed –both for new and longer-established EOTs.

This article aims to highlight some of the key points that trustees and boards should be alive to.

Tax relief on distributions is not always automatic

A typical EOT sale will usually involve the EOT acquiring shares from the shareholders (“the Vendors”) in the trading company (“the Company”) in return for cash and deferred consideration.

As the EOT is often established by the Company, it will not typically have any funds of its own at the point of acquisition. Common practice has therefore been for EOTs to be funded by voluntary contributions from the Company around completion, with the EOT using those funds to discharge any initial consideration (and then any deferred consideration) owed to the Vendors. The safest course of action may be to treat such contributions as distributions (see below).

Outside of an EOT context, a contribution of funds from a company to its shareholder, without anything given in return, would ordinarily be treated as a dividend in the hands of the shareholder. Without any special rules for EOTs, this created the risk that the EOT trustees, as shareholders, would be subject to income tax on a dividend at up to 39.35%. That outcome would have been extremely damaging to the EOT model.

Accordingly, prior to 30 October 2024, many EOTs were routinely established on the basis that HM Revenue & Customs (“HMRC”) agreed that contributions to an EOT were not taxable and this was often supported by transaction structuring. In many cases, a non-statutory clearance was sought and obtained from HMRC to confirm this treatment.

Changes introduced at the 30 October 2024 Budget placed this position on a statutory footing by introducing a formal relief. Under the new rules, certain distributions (broadly, payments made in relation to the sale to the EOT) made by the Company to the EOT on or after 30 October 2024 are not taxable in the hands of the EOT provided a valid relief claim is made by the trustees. Trustees should carefully review any proposed or actual distributions and take advice on whether relief can be claimed.

Whilst care is needed, the change in rules to introduce a statutory relief was widely welcomed. Legislating for relief reduced the risk of HMRC challenge and, for EOTs established on or after 30 October 2024, the need to make relief claims is clear.

However, the new rules do create a practical risk for EOTs established before 30 October 2024, where trustees often assume that:

• distributions paid up from the Company to the EOT are automatically tax-neutral;
• responsibility for dealing with the tax position sits entirely with the Company or its accountants; or
• a historic non-statutory clearance from HMRC removes the need to make a relief claim.

These assumptions are not correct. In particular, HMRC guidance does not fully align with the statutory position. As a result, the most prudent approach is for all EOTs to consider making relief claims in respect of distributions received after 30 October 2024, regardless of when they were established.

Where a required claim is not made, the result can be unexpected tax leakage at the trust level, which is often only identified after distributions have already been paid. This can be expensive for the trust and ultimately the Company that would usually need to fund this.

For example, if the Company distributes £1 million to its EOT without a valid relief claim, who then repays £1m of vendor debt, the EOT would be subject to income tax at up to 39.35% (£393,500) but would not usually have the funds to pay this. Funding that tax liability would typically require a further distribution from the Company, which may itself not qualify for relief. To fund the trustee’s tax bill might therefore require a further dividend of £648,805 (being £393,500 x 100 / (100 - 39.35)). In practice, this could mean that the Company is having to find £1.65m to make a £1m repayment to the vendor via the EOT.

This is an area where the requirements for practical application are distinct and separate from the transaction itself.

How relief is claimed

Relief is not automatic and must be claimed by the trustees. In practice, claims may be made through the trust’s tax reporting or by separate submission to HMRC.

The appropriate approach will depend on the specific circumstances of the EOT and should be considered carefully.

Company law: are there sufficient distributable reserves?

Separate from the tax position, under company law any distribution must be supported by sufficient distributable reserves, determined by reference to the Company’s relevant accounts.

Distributable reserves are defined as a company’s:

“accumulated, realised profits, so far as not previously utilised by distribution or capitalisation, less its accumulated, realised losses, so far as not previously written off in a reduction or reorganisation of capital duly made.”

In practice, the starting point will usually be the Company’s most recent statutory accounts. However, where there have been material changes since those accounts were prepared - for example, a significant transaction, restructuring or exceptional movement in profits - reliance on historic accounts alone may not be sufficient. In such cases, properly prepared interim accounts may be required to demonstrate that sufficient distributable reserves exist at the time the distribution is made.

A number of additional points are frequently overlooked:

• historic transactions - including the original EO transaction, debt structuring or group reorganisations -  can materially affect the level of distributable reserves;
• the existence of cash, even in significant amounts, does not of itself mean a lawful distribution can be made;
• the profit and loss reserve shown on the balance sheet is not necessarily equal to distributable reserves, as it may include unrealised profits or exclude amounts held elsewhere within equity, and;
• the need for Board minutes to reflect that the directors have considered whether there are sufficient distributable reserves by reference to relevant accounts.

If the latest statutory accounts show reserves that are materially lower than the current cash position, properly prepared interim accounts will often be required to demonstrate that sufficient distributable reserves exist at the time the distribution is made. These do not need to be formal, and in some cases management accounts may suffice, but due consideration must be given to any accounting adjustments that might affect distributable reserves and an audit trail preserved.

By way of illustration, the Company might receive a substantial inflow of cash from an exceptional transaction, significantly increasing its cash balance. That cash will not automatically represent distributable reserves for company law purposes. In particular, if the transaction is not reflected in the Company’s relevant accounts, it may not be possible to rely on that cash to support a lawful distribution. In such circumstances, interim accounts may be required to demonstrate that sufficient reserves exist for distributions to the EOT to enable , for example, repayment of  some or all of its outstanding vendor debt.

Where distributions are made without sufficient distributable reserves, the consequences can include:

• the payment being considered void;
• obligations on shareholders or trustees to repay the distribution;
• potential personal exposure for directors; and
• further, often unexpected, tax consequences.

If nothing else, it may result in unwelcome questions or reviews from HMRC which, even if no issues are found, does impact on resources and creates unnecessary anxiety.

Why this matters



Distributions are sometimes viewed as a routine post-transition matter. In reality, they are one of the most common areas where EO structures experience avoidable friction - particularly as legislation evolves and EOTs mature.

Trustees and boards should treat distributions as a multi-disciplinary issue, rather than a purely mechanical one, because they sit at the intersection of:

• corporate law (board decisions and reserves);
• trust taxation, and;
• trustee governance.

Problems often arise where:

• the Company assumes the trustees have dealt with the tax position, and vice versa;
• the Company and trustees assume the Company’s advisers have covered everything; or
• no one has clearly documented who is responsible for what, or what is required.

From a governance perspective, trustees and boards should be comfortable that:

• they understand the basis on which distributions are being made;
• they are satisfied that distributions do not adversely impact the business and its employees;
• any required claims or filings have been identified and addressed; and
• advice has been taken where the position is unclear.

As with anything, clarity of the detail, clearly documented process and audit trails of actions can avoid unintended consequences being crystallised.

This article was written by Steven Tebbutt, a tax adviser at MHA (MHA | Steven Tebbutt), and Andrew Evans a legal and tax adviser at Geldards (Andrew Evans Partner Lawyer/Solicitor | Geldards Law Firm), with input from IDT.

Although both authors are EO experts this article is intended as a general overview only and does not constitute tax or legal advice. Individual circumstances will differ. If you would like to discuss your specific scenario with an expert, please follow the links to speak directly with Steven or Andrew.