Corporate update: the latest corporate law developments October 2023

Proposed changes to employee ownership trusts

A consultation by HMRC on changes to the taxation of Employee Ownership Trusts (EOTs) aims to ensure that use of the structure remains focused on the original policy objectives of encouraging employee ownership and rewarding employees. The Government is concerned that the structure is being used outside of these purposes, to obtain a tax advantage on a company sale.

What is an EOT?

An EOT is a type of employee benefit trust which offers indirect ownership of shares by employees. The purpose of an EOT is to hold a controlling interest in a company for the long term benefit of the company’s employees as a whole. Various studies have shown that greater employee engagement and commitment results from employees having a stake in their company, leading to those companies being more resilient, adding more staff and generally being more profitable.

According to the Employee Ownership Association, there are now over 1,400 employee owned businesses in the UK. In the year to June 2023, the top 50 employee owned businesses generated over £23bn of sales and employed over 181,000 people.

What are the tax advantages associated with an EOT?

In order to encourage greater employee ownership across UK businesses, in 2014 the Government introduced certain tax advantages for businesses that moved to an EOT structure. In particular:

• Capital gains tax: there is full CGT relief for the selling shareholder(s) on the sale of a controlling interest to an EOT.
• Income tax: the EOT-owned company can pay each of its employees an income tax free bonus of up to £3,600 per year.
• Inheritance tax: there is no IHT charge on the transfer of shares to an EOT and the EOT itself is exempt from the IHT relevant property regime.

What changes are being proposed?

As noted above, the Government is concerned that the tax advantages of selling to an EOT mean that the structure is being used to facilitate a tax-free realisation of value for company owners without any genuine increase in employee engagement. So, one of the key proposals in the consultation is aimed at preventing a former owner from retaining control of the company via the EOT trustee board. The proposal would require more than half of the EOT trustees to be people other than the former owner or people connected to them.

The Government is also concerned that the strict rules relating to the tax-free bonus are making it difficult for companies to actually award those bonuses. In particular, issues arise with the “participation requirement”, which prevents bonuses being paid where the proportion of directors to employees in any individual company in the group exceeds a ratio of 2/5, and the “officer holder requirement”, which requires non-executive directors (as employees) to receive a bonus. To resolve these issues, the Government proposes amending the rules so that tax-free bonuses can be awarded without directors also having to be included.

To ensure that EOTs are not used to avoid CGT on any subsequent sale of the EOT-owned company, the consultation proposes a requirement that the trustees of an EOT be UK resident as a single body of persons. This would require that either the trustees of the EOT all be UK resident; or that the trustees be a mix of UK resident and non-UK resident and that the former owner was UK resident at the date the shares were disposed of to the EOT.

Finally, there is currently uncertainty over the tax status of payments made by an EOT-owned company to the EOT trustees in order to repay the former owners for the acquisition cost of the company’s shares. Whilst HMRC routinely gives clearance to confirm that such payments are not taxable, there are concerns that they could be treated as dividends. As a result, the consultation includes proposals to clarify that these payments will not be treated as distributions.

Comment

EOTs have become the main form of employee ownership in the UK. According to the Employee Ownership Association, 332 new EOTs were created in 2022, an increase of 37% on the previous year. But clearly there are concerns that the structure is being abused in order to gain a tax advantage in circumstances which fall outside the original intended purpose of an EOT. Whilst these reforms aim to address that misuse, they will also bring welcome clarity and flexibility to certain aspects of the EOT model.

The consultation closed on 25 September 2023 and it remains to be seen which proposals will be taken forward.

Company Names Tribunal: court confirms approach to appeals of Tribunal decisions

In AXA Wholesale Trading V AXA [2023] EWHC 1339 (Ch), the High Court confirmed that when considering appeals from the Company Names Tribunal (Tribunal) it would be reluctant to interfere with decisions unless a distinct and material error of principle was shown. In this case, there had been no such error and as the relevant defences had not been made out, the appeal was dismissed.

What does the Company Names Tribunal do?

The Tribunal deals with complaints relating to a registered company’s name, but only in very specific circumstances. An applicant can raise an objection with the Tribunal if they have goodwill or a reputation in a name, and that name is identical or very similar to the registered company name that the applicant is contesting. The Tribunal will consider a name to be sufficiently similar if its use in the UK would be likely to mislead by suggesting a connection between the registered company and the applicant.

The Tribunal has stressed the importance of an applicant having goodwill in the registered name and that they should also suspect that the name has been registered to extract money from the applicant or to prevent the applicant from registering the name themselves. The Tribunal will not deal with cases where a person feels that another company registration is too similar to their own company name, but where there is no suspected opportunism behind the registration.

There are several statutory defences available to the registered name holder, including that the company name was adopted in good faith and that the interests of the applicant were not adversely affected by the registration to any significant effect. If the Tribunal upholds a complaint, it must order the company to change its name, but decisions of the Tribunal can be appealed in the High Court.

The case

The case concerned an appeal to the High Court by AXA Wholesale Trading Ltd (AWT) against an earlier decision of the Tribunal requiring AWT to change its name.

The Tribunal had ordered the change of name following an application by the French insurance and financial services group, AXA. AXA operated worldwide insurance and financial services businesses and had a substantial reputation in the UK.

The Tribunal had agreed with AXA’s complaint that AWT’s name was sufficiently similar to AXA’s and that its use in the UK would be likely to mislead people by suggesting a connection between the two companies.

Appeal decision

The High Court dismissed AWT’s appeal against the Tribunal’s decision. In doing so, it held that when considering an appeal it would adopt the same approach as it did on appeals from the trade mark registration decisions of the UK Intellectual Property Office (IP Office). This approach was appropriate as the legal exercise undertaken by the IP Office and the Tribunal were similar.

Using this approach, the Court confirmed that an appeal against a decision of the Tribunal would be allowed where there was an error of law. However, where the Tribunal had made its decision based on an assessment of several different sources of evidence and other factors, the Court would be reluctant to interfere unless the Tribunal had made a distinct and material error of principle.

The Tribunal had correctly found that AXA had goodwill in the registered name and AWT had not made out the statutory defences of registration in good faith or lack of significant adverse effect on AXA’s interests. As a result, the appeal failed.

Comment

Filing an objection with the Tribunal can be a very effective way of stopping a company from using a registered name. However, an application to the Tribunal can be a costly and time-consuming process and, as the Tribunal has pointed out, if an application is made to it in error, the applicant will not receive a refund.

Most importantly, the applicant must have demonstrable goodwill or a reputation in the name at the time that it was adopted by the registration holder. If no defence is filed (as is commonly the case) then the applicant’s complaint will be successful. There are, however, statutory defences that the registered holder can rely on, but these defences will not be available if the applicant can show that the main purpose of registering the company name was to obtain money or to prevent the applicant from registering the name.

The AXA case is useful in that it confirms how the Court will approach appeals of Tribunal decisions. Appeals are already relatively rare, but the AXA decision may help prevent pointless and costly appeals where it appears that the Tribunal has not made any distinct and material error of principle. If the Tribunal reached its decision based on the factual evidence presented to it and by correctly applying the law to those facts, then the chances of a successful appeal to the Court will be remote.

UK prospectus regime reform: what does it mean for AIM (and other MTFs?)

The Government is pushing forward with its proposals for an overhaul of the UK prospectus regime. We consider how those proposals might affect AIM and other multilateral trading facilities (MTFs).

Background

Following Lord Hill’s 2021 UK Listing Review, the Government has been consulting on changes to the legislative framework for listed companies and, in particular, the prospectus regime. The objectives behind the reform include encouraging more retail participation in securities offers, simplifying the regulation of prospectuses without lowering regulatory standards and improving the quality of information investors receive under the prospectus regime.

In July 2023, the Government published a near-final version of the regulations – The Public Offers and Admissions to Trading Regulations 2023 (2023 Regulations) – that will set out the new prospectus regime once the current UK Prospectus Regulation has been repealed. Although the 2023 Regulations are potentially far-reaching, much of the detail behind the new regime has been delegated to the FCA and the FCA will need to consult on and implement new rules to bring the reforms into effect. As part of this consultation process, the FCA has published a series of engagement papers that give an indication of how the FCA intends to use its powers in relation to different aspects of the regime.

The new regime and admissions to AIM

Under the current regime, if there is no offer to the public, a prospectus will not be required for the admission of securities to a non-regulated market such as AIM (or other similar MTF). Admission of securities to AIM is currently regulated by the AIM Rules. An AIM admission document is not reviewed by the FCA and although similar to a prospectus, it has different standards of liability and some of the prospectus content is carved out.

In a key change to the regime, the 2023 Regulations will give the FCA enhanced rule-making responsibilities to decide whether a prospectus is required whenever an issuer is admitting securities to trading on a regulated market or on a “Primary MTF” (which would include AIM).

Rather than regulating admissions directly, the FCA will have the power to require relevant Primary MTFs to include certain provisions in their own rules and these could include requiring an issuer to publish a prospectus in specified circumstances.

FCA policy on AIM admissions

In July 2023, the FCA published Engagement Paper 6 setting out how it intends to use its prospectus requirement powers in relation to primary MTFs such as AIM.

The FCA is proposing that all Primary MTFs that allow retail participation should amend their rules to require the publication of an “MTF admission prospectus” for:

• initial admissions to trading; and
• reverse takeovers that involve the admission to trading of newly issued securities.

Under this approach, an MTF admission prospectus would be the only type of admission document for all new admissions to trading on in scope Primary MTFs.

Crucially, the FCA does not expect there to be a material change in the steps involved in compiling and validating the information disclosed in an MTF admission prospectus. Specific content requirements will be set by the MTF operator, as will the process for reviewing and approving the documents. The FCA will not be responsible for reviewing these admission prospectuses.

Although content requirements for the new MTF admission prospectus will be set by the Primary MTF, they will be subject to the same liability regime as currently exists for FCA approved prospectuses. That means that persons responsible for the document (e.g. the issuer and its directors) will be liable to pay compensation to investors who have suffered a loss as a result of untrue or misleading statements or omissions. This is a significant departure from the current regime.

The FCA is not intending to require an MTF admission prospectus for secondary issues of securities already trading on the Primary MTF. It is, however, considering the circumstances in which a supplementary MTF admission prospectus might be required and also when withdrawal rights would be exercisable.

Comment

The introduction of an MTF admission prospectus is likely to be welcomed by companies wanting to make a retail offer on AIM (or other MTF). The ability to include retail investors without the need for an FCA approved prospectus will be an attractive option and should increase retail participation in AIM IPOs.

Less attractive to the directors of AIM companies will be the increased liability they will have for MTF admission prospectuses. Nomads would also be well advised to assess the changes to the regime carefully to determine what additional risks and responsibilities may be implied, and how this might impact the IPO process for AIM companies.

In terms of timing, the FCA intends to work on developing specific rule proposals following completion of its engagement process and will consult on these rules during 2024. As a result, the new regime is unlikely to be fully effective before Q4 2024/Q1 2025.

First published in Accountancy Daily.