Selling your company to an employee ownership trust no longer takes the gain out of charge to capital gains tax. For disposals made on or after 26 November 2025, section 35 of the Finance Act 2026 amended section 236H of the Taxation of Chargeable Gains Act 1992 so that only 50% of the gain is exempt. The other half is a chargeable gain in the year of disposal, taxed under the normal rules, and a claim to employee ownership trust relief now switches off Business Asset Disposal Relief and Investors’ Relief on the same disposal entirely.
A great deal of the guidance still online describes the old position, in which a qualifying disposal to an employee ownership trust was treated as made for a consideration producing neither a gain nor a loss. That treatment survives only where no gain accrues. If you are reading an article that promises a tax-free exit, check its date. This article sets out what the law says as it stands on 6 October 2026, how an employee ownership trust sale actually works, what the nine qualifying conditions mean in practice, where the money comes from, what you give up, and the cases in which an employee ownership trust is the wrong answer.
What an employee ownership trust actually is
An employee ownership trust is a form of employee benefit trust that holds a controlling interest in a trading company for the benefit of all that company’s employees, on the same terms. It is not a share scheme. Individual employees do not receive shares, do not hold them personally and cannot sell them. The trust holds the shares indefinitely and the employees are beneficiaries of the trust rather than shareholders in the company.
The trustee is almost always a company incorporated for the purpose, with a board drawn from management, employee representatives and, usually, an independent trustee director. The trustee company’s directors owe their duties to the beneficiaries as a whole, which is a materially different thing from a board owing duties to the company.
The structure was created by Schedule 37 to the Finance Act 2014, which inserted sections 236H to 236U into the Taxation of Chargeable Gains Act 1992. Those sections remain the main body of law, as amended by Schedule 6 to the Finance Act 2025 and section 35 of the Finance Act 2026. The policy intention, restated by HMRC in the Budget 2025 policy paper, is to support employee ownership as a business model while making sure that sellers of valuable shareholdings pay some tax on their gains.
How an employee ownership trust sale works, step by step
The mechanics are closer to a management buy-out than to a trade sale, with one critical difference: the buyer starts with no money. Understanding where the cash comes from is the single most important thing a seller needs to grasp before committing to this route.
- Feasibility and valuation. An independent valuer prepares a market valuation of the company and, just as importantly, a view on what the company can afford to pay out of future profits without starving itself of working capital. The affordability model usually matters more to the outcome than the headline valuation.
- Trust formation. A trustee company is incorporated and a trust deed is executed establishing the employee ownership trust. The deed has to be drafted so that the all-employee benefit requirement and the trustee independence requirement are met from the outset and continue to be met.
- Share purchase agreement. The trustee buys more than 50% of the ordinary share capital from the existing shareholders. The agreement looks like a conventional share purchase agreement but with much lighter warranty cover, because the trustee is buying a company the sellers have been running and the warranty package is often replaced or heavily supplemented by a disclosure exercise and a set of specific indemnities.
- Initial payment. The company makes a contribution to the trustee out of its existing cash reserves, and the trustee pays that amount to the sellers on completion. Some deals add third party debt at this stage to increase the day one payment.
- Deferred consideration. The balance of the price, usually the majority of it, is left outstanding as a debt owed by the trustee to the sellers, payable over a period commonly between five and ten years.
- Repayment from trading profits. Each year the company makes further contributions to the trustee, and the trustee uses them to pay down the deferred consideration. The company’s ability to keep making those contributions is what determines whether the sellers actually get paid.
That final point is the heart of it. The sellers are not being paid by a buyer with its own balance sheet. They are being paid by the business they have just handed over, out of profits that have not yet been earned, by a trustee whose only meaningful asset is the shares it bought from them.
Where the money comes from
| 1. Company trading profits | Generated by the business after completion, plus any cash reserves held at completion |
| 2. Contribution to the trustee | The company pays cash to the trustee of the employee ownership trust. Where the payment is a distribution, section 401ZA of the Income Tax (Trading and Other Income) Act 2005 lets the trustee deduct its acquisition costs from it, so the contribution is not taxed in the trust |
| 3. Trustee pays the sellers | Applied against the deferred consideration owed under the share purchase agreement, with interest at no more than a reasonable commercial rate |
| 4. Repeat annually | Until the deferred consideration is cleared, typically five to ten years. If profits fall, payments are deferred or renegotiated. There is no third party guaranteeing them |
Trustee acquisition costs for section 401ZA include the purchase price, repayment of borrowings taken to fund it, interest at no more than a reasonable commercial rate, the valuation, stamp duty or stamp duty reserve tax, and other reasonable expenses directly connected with the acquisition.
The qualifying conditions in plain English
Section 236H(4) sets out the relief requirements. Three were added by Schedule 6 to the Finance Act 2025 with effect for disposals made on or after 30 October 2024, and they are the ones that catch out structures designed before that date. The conditions are not one-off tests at completion. Most of them have to be met at the time of the disposal and continue to be met for the rest of the tax year, and several have to keep being met for four further tax years.
Qualifying conditions checklist, section 236H(4) TCGA 1992
| Condition | What it means in practice | When it must be met |
|---|---|---|
| Trustee residence s.236H(4)(za), added 2024 | The trustees must be UK resident. Offshore trustee structures no longer qualify, and an existing trust cannot be migrated out without consequences | At disposal and for the rest of that tax year |
| Trading requirement s.236I | The company must be a trading company, or the principal company of a trading group, whose activities do not include non-trading activities to a substantial extent. Investment-heavy balance sheets are a real risk here | At disposal and for the rest of that tax year |
| All-employee benefit ss.236J to 236L | The trust must benefit all eligible employees on the same terms. Benefits may be varied only by reference to salary, length of service or hours worked. No sub-trusts, no loans to beneficiaries, and no amendment of the trusts to get round any of this | At disposal and for the rest of that tax year |
| Trustee independence s.236LA, added 2024 | Fewer than 50% of the trustees may be excluded participators, broadly the former owners and people connected with them, and excluded participators must not control the settlement. This is the condition that stops a seller running the trust that owes them money | At disposal and for the rest of that tax year |
| Controlling interest s.236M | The trustees must hold more than 50% of the ordinary share capital, more than 50% of the votes, more than 50% of distributable profits and more than 50% of assets on a winding up, with no agreement allowing any of that to be lost without their consent | Not met before the tax year begins, met by the end of it |
| Trustee valuation s.236H(4)(ca), added 2024 | The trustees must take all reasonable steps to secure that the price does not exceed market value, and that interest on any deferred consideration does not exceed a reasonable commercial rate. In practice this means an independent valuation the trustee has genuinely interrogated, not one the seller commissioned and handed over | At the time of the disposal |
| Limited participation s.236N | The participator fraction must not exceed two fifths. Broadly, the number of 5% shareholders who are employees or office holders, plus employees connected with them, divided by total employee numbers. Small companies with several shareholder-directors can fail this on headcount alone | Throughout the 12 months ending immediately after the disposal, and to the end of that tax year |
| No earlier related disposal s.236H(4)(e) | Relief is not available if you or a connected person already claimed it on a related disposal in an earlier tax year. Selling in tranches across tax years to spread the tax does not work | Historic test at the date of disposal |
| Claim content s.236H(7), expanded 2025 | The claim must identify the trust and the company, give the date of disposal and number of shares, the number of employees at the date of disposal, and the consideration including amounts due after the disposal | Claims made on or after 6 April 2025 |
The trustee independence requirement and the valuation requirement are the two that most often need a structure rethinking. A seller who expected to remain in control of the trustee board, or to set the price themselves and have the trustee accept it, is designing a transaction that does not qualify. Section 236LA goes further than counting trustee seats: excluded participators must not have the power, acting without the independent trustees, to apply trust property, vary or terminate the settlement, add or remove beneficiaries, or appoint or remove trustees. A veto buried in the trust deed can fail the test even where the board arithmetic looks right.
The tax position as the law stands on 6 October 2026
What changed on 26 November 2025
Section 35 of the Finance Act 2026 replaced section 236H(2) of the Taxation of Chargeable Gains Act 1992 with a new subsection (2) and a new subsection (2A). Where a gain accrues on a qualifying disposal and a claim is made, subsection (2A) now provides that only 50% of the gain is a chargeable gain. The amendment has effect in relation to disposals made on or after 26 November 2025, which was Budget day. The old no gain, no loss treatment in subsection (3) survives only in the case where no gain accrues at all.
For 2026 to 2027, the chargeable half is taxed at 18% to the extent it falls within the basic rate band once added to taxable income, and 24% above it. The annual exempt amount is £3,000. On a £4 million gain, a higher rate taxpayer selling to an employee ownership trust is looking at roughly £480,000 of capital gains tax where, before 26 November 2025, the figure was nil.
The other 50% is deferred, not forgiven
This is the point most commentary skips, and it matters to the trustee and to the employees who come after you. Section 236H(2A)(d) provides that the trustees are treated as acquiring the shares for the consideration paid less the part of the gain that is not chargeable. The exempt half is held over and reduces the trust’s base cost. HMRC’s policy paper of 26 November 2025 puts it plainly: the remaining 50% of the gain is not chargeable at the time of disposal but is held over to come into charge on any future disposal of the shares by the trustees.
So the trust inherits a latent gain. If the employee ownership trust ever sells the company on, or suffers a deemed disposal under section 236P, the deferred half resurfaces as a chargeable gain in the trust, taxed at the trustee rate of 24% for 2026 to 2027. Any trustee being asked to approve a purchase should understand that it is taking on a tax liability as well as a debt.
Business Asset Disposal Relief and Investors’ Relief are switched off
Section 236H(2A)(b) provides that a disposal on which employee ownership trust relief is claimed is not a qualifying business disposal for the purposes of Business Asset Disposal Relief. Paragraph (c) treats the shares as excluded shares for Investors’ Relief. You cannot claim employee ownership trust relief on part of a shareholding and Business Asset Disposal Relief on the rest of the same disposal, and the earlier related disposal rule in section 236H(4)(e) blocks the obvious workaround of splitting the sale across tax years.
That makes the comparison between the two routes a live one again, which it was not when employee ownership trust relief took the whole gain out of charge. For disposals from 6 April 2026 Business Asset Disposal Relief charges 18% on gains up to a lifetime limit of £1 million, after which the normal rates apply. Employee ownership trust relief exempts half the gain with no cap. On a gain of £1 million the two routes are close. On a gain of £10 million the employee ownership trust route is still far ahead in cash terms. We cover the relief itself, its conditions and its two year qualifying period, in our article on Business Asset Disposal Relief for sellers.
Paying tax on money you have not yet received
Here is the practical problem the 2025 change created, and it is the question we are asked most often. The disposal happens on completion. The chargeable gain arises in that tax year and is calculated on the full consideration, including the deferred element. But in a typical employee ownership trust sale you receive perhaps 20% of the price on day one and the rest over the following five to ten years. The tax can easily exceed the cash.
Section 280 of the Taxation of Chargeable Gains Act 1992 is the answer, and HMRC’s helpsheet HS277 confirms it applies here. Where the consideration is payable in instalments, you may apply to pay the tax in instalments provided the instalments begin no earlier than the date of disposal, extend over a period exceeding 18 months, and continue beyond the date the tax would otherwise be due. The application is made in writing to HMRC’s capital gains tax queries address, with the heading clearly referring to section 280 TCGA 1992. It is not automatic and it is not granted by ticking a box on the return, so it needs to be planned before completion rather than discovered in January. Your accountant should model the cash position across the whole payment schedule before you sign anything.
The employee bonus and the company’s position
Once the trust holds a controlling interest, the company can pay qualifying bonus payments of up to £3,600 per employee per tax year free of income tax under section 312A of the Income Tax (Earnings and Pensions) Act 2003. The exemption does not extend to National Insurance contributions, which follow the normal treatment for earnings, and HMRC’s Employment Income Manual at EIM03050 says so expressly. Any adviser presenting the bonus as entirely tax free is wrong. Since 30 October 2024, the participation requirement for these bonuses is not infringed simply because directors are excluded from an award.
There is also an inheritance tax point worth knowing. Section 28A of the Inheritance Tax Act 1984 makes a transfer of value by an individual to an employee ownership trust an exempt transfer, provided the trading, all-employee benefit and controlling interest requirements are met, with the controlling interest test applied across the tax year in the same way as for capital gains tax.
Everything in this section is the law and the process. The numbers that matter to you depend on your base cost, your other income and gains, your residence and the timing of the instalments. Confirm your own position with your accountant or tax adviser before you commit to a structure.
Clawback: four tax years on you, then the trustees
Schedule 6 to the Finance Act 2025 extended the clawback window substantially, with effect for disposals made on or after 30 October 2024. Section 236O used to bite only where a disqualifying event happened in the tax year following the disposal. It now applies where a disqualifying event occurs in any of the first four tax years following the tax year of disposal. Depending on when in the tax year you complete, that is a period of up to almost five years during which the structure has to hold.
A disqualifying event under section 236O(2) is the trustees ceasing to be UK resident, the company ceasing to meet the trading requirement, the settlement ceasing to meet the all-employee benefit requirement, the settlement ceasing to meet the trustee independence requirement, the settlement ceasing to meet the controlling interest requirement, the participator fraction exceeding two fifths, or the trustees acting in a way the trusts do not permit. If one happens in that window, no claim may be made and any claim already made is revoked, with the chargeable gains recalculated as if it had never been made. Section 236O(5) disapplies the normal time limits on assessments to let HMRC collect.
The liability for that falls on the seller, not on the trust, and it is a liability for events happening years after you have ceased to have any control over the company. That is why the trust deed and the post-completion governance arrangements are not administrative tidying up. They are part of your tax position. A limited exception applies where the only cause of a breach of the residence or trustee independence requirement is the death of a trustee or of a director of a corporate trustee, and the position is corrected within six months.
After that four year window closes, the risk moves. Section 236P provides that on the first disqualifying event occurring after the end of the fourth tax year following the acquisition, the trustees are treated as having disposed of and immediately reacquired the shares at market value. The deferred half of your gain, sitting in the trust’s reduced base cost, crystallises there. Your relief is safe. The trust takes the hit. Very little published guidance separates these two regimes, and the distinction decides who carries the risk at any given point.
What you give up as a seller
An employee ownership trust sale is frequently presented as the exit with no downside. It is not. Here is what you are actually trading away.
- Price certainty. The price must not exceed market value, the trustee must take all reasonable steps to confirm that, and there is no competitive tension. A trade buyer with a strategic reason to acquire you may pay well above an independent valuation. The trust cannot.
- Payment certainty. Most of your consideration is a debt owed by a trustee company whose only asset is shares in a business you no longer run, serviced out of profits that have not been earned. If trading deteriorates, you wait, you renegotiate, or you take less. The risks are the same as on any deferred consideration arrangement in a business sale, with the added difficulty that enforcing against the trust means damaging the business that is meant to pay you.
- Security. Taking a charge over the company’s assets to secure your deferred consideration sits awkwardly with the trustee’s duties and with any bank funding, so sellers often end up less well secured than they would be on a trade sale.
- Control of the trust. The trustee independence requirement means you cannot control the body that owes you money. You can usually keep a seat, and many sellers stay on as a director of the trading company for a transition period, but you cannot hold the casting vote.
- Reinvestment in the business. Every pound the company pays the trustee is a pound not spent on growth. If the business needs capital investment over the next five years, the payment schedule and the investment plan are in direct competition.
Governance after the sale
Employee ownership changes who the company answers to, and the businesses that make it work are the ones that treat governance as a design question rather than a formality. In most structures there are three layers: the trading company board, which continues to run the business day to day; the trustee board, which holds the shares and exercises the shareholder functions; and an employee council or forum, which gives employees a voice and usually a route to appoint one or more employee trustee directors.
The trustee board’s duties run to the beneficiaries as a whole, which includes future employees as well as current ones. That has real consequences. A trustee cannot simply approve whatever payment schedule suits the sellers if doing so would jeopardise the company. It will want reporting rights, information covenants and a reserved matters list, which is a familiar discipline to anyone who has negotiated a shareholders’ agreement.
The employment side also deserves more attention than it usually gets. Employee ownership does not change anyone’s contract of employment, does not create employee shareholder rights, and does not of itself alter redundancy or disciplinary processes. We advise companies on getting the employment law framework right alongside the trust structure, including how bonus arrangements interact with existing contractual entitlements.
When an employee ownership trust is not the right exit
We act on both sides of business sales, and we would rather tell a client this route is wrong for them than run a transaction that fails in year three. These are the situations in which an employee ownership trust is usually the wrong answer.
- You need the money now. If you need the bulk of the consideration at completion, an employee ownership trust will not deliver it. The company’s cash reserves set the ceiling on the day one payment, and that is rarely more than a modest fraction of the price.
- Profits are volatile or thin. The whole structure depends on predictable, sustained profitability for the length of the payment period. A business with cyclical earnings or wafer thin margins cannot service the debt, and a trustee properly advised will not agree a schedule it cannot meet.
- There is no management team. If the business runs on you, taking you out of it destroys the thing that is meant to pay for your shares. A credible second tier of management has to exist before the sale, not be created by it.
- A trade buyer will pay a strategic premium. Where a competitor or consolidator values your client list, licences or location well above an independent valuation, selling to an employee ownership trust means knowingly leaving money on the table. That is a legitimate choice, but make it with the number in front of you.
- Your shareholder group fails the participation tests. Several shareholder-directors in a small workforce can breach the two fifths participator fraction, and a shareholder who wants to stay with real influence sits badly against the trustee independence requirement.
- The company is not sufficiently a trading company. A substantial investment property portfolio or large surplus cash balances can take a company outside section 236I, and the usual fix, extracting the non-trading assets first, carries its own tax consequences.
- Only part of the business is being sold. Employee ownership trust relief applies to a disposal of shares in the company. If you want to carve out a division or keep particular assets, you are in different territory. Our comparison of a share sale and an asset sale sets out why that distinction drives so much of the structure.
Where the business has a strong management team that wants to buy but cannot fund a full purchase, a management buy-out or buy-in is often the better comparison. It gives you a buyer with its own incentives and access to debt and private equity funding, usually a larger day one payment, and none of the continuing qualification risk that a trust structure carries. The trade-off is that the management team ends up owning the business rather than the workforce as a whole.
What to do before you commit
An employee ownership trust sale is still a genuinely attractive route for the right company. Exempting half a gain of any size, with no lifetime cap, is a substantial relief, and for owners who care about what happens to their staff and their business after they leave, it does something no trade sale can. But the 26 November 2025 change means the decision now needs a cash flow model as well as a values conversation. Work through the valuation and affordability analysis first, confirm the structure can meet all nine conditions and keep meeting them for four further tax years, get the section 280 instalment position agreed with your accountant, and only then start drafting.
The wider preparation is the same as for any exit. Getting your corporate records, contracts, property and employment documentation in order before anyone starts asking questions saves time and preserves value, and we set out the full process in our legal guide to selling a business in the UK.
Talk to us before the structure is fixed
We advise owner-managed businesses across London and the South East on selling a business, on management buy-ins and buy-outs, and on mergers and acquisitions, and we act for trustees as well as sellers. The point at which legal advice makes the most difference on an employee ownership trust sale is before the heads of terms are signed, when the valuation methodology, the payment schedule, the trustee board composition and the security position are all still open.
If you are weighing an employee ownership trust against a trade sale or a management buy-out, or you have a structure that was designed before the 2024 and 2025 changes and needs checking against the current conditions, we would be glad to talk it through. Call us on +44 207 566 1188 or email info@gurvelegal.com.
