The participator ratio is one of the key eligibility tests for Employee Ownership Trusts (EOTs) in the UK. It determines whether the sale to an EOT qualifies for tax benefits, including the partial Capital Gains Tax relief for selling shareholders and the £3,600 annual tax-free bonus for employees.
For most straightforward owner-managed companies, it’s clear cut: you either comfortably meet, or clearly fail to meet, the 40% ratio. But for other businesses, it can get tricky, especially if your company employs family members, has multiple share classes, share option schemes, shareholders that don’t work for the company, or corporate shareholders.
Even defining who counts as an “employee” can cause confusion. Do part-time workers count? What about contractors or overseas staff? Working out exactly what number should sit on the top and bottom of the fraction can quickly get complex.
This guide is here to help you clear up uncertainties and work out whether your business meets the required ratio.
What is the EOT Participator Ratio?
The EOT participator ratio compares the number of core shareholders, and their close associates, with the number of employees. To qualify for EOT tax perks, “participators” must make up no more than 40% of the total employee headcount.
You need to meet this threshold for at least 12 months before selling to an EOT, and for 4-5 years after the sale. It’s worth taking time to look at this early in your planning stages. If you fall just above the 40%, you may be able to make adjustments now so your business is ready for an EOT sale in a year’s time.
What the legislation says
Step 1 – What is a participator?
The full explanation comes from Section 454 of the Corporation Tax Act 2010, which defines a participator as anyone who owns shares or has the right to acquire them:
a person who possesses, or is entitled to acquire, share capital or voting rights in the company
In practice this means:
- Shareholders
- Anyone with share options (because they are “entitled to acquire”)
Step 2 - Limited participation requirement
This comes from Section 236N of the Taxation of Chargeable Gains Act 1992:
(1) The limited participation requirement is met if Conditions A and B are met.
(2) Condition A is that there was no time in the period of 12 months ending immediately after the disposal mentioned in section 236H(1) when—
(a) P was a participator in C, and
(b) the participator fraction exceeded 2/5.
(3) Condition B is that the participator fraction does not exceed 2/5 at any time in the period beginning with that disposal and ending at the end of the tax year in which it occurs.
(4) But a time which falls in a period during which the participator fraction exceeded 2/5 is to be disregarded for the purposes of subsection (2)(b) and (3) if—
(a) that period lasts no more than 6 months, and
(b) the fraction exceeded 2/5 during that period by reason of events outside the reasonable control of the trustees.
(5) “The participator fraction” means—
NP
—
NE
where—
NP is the sum of—
(a) the number of persons who at the time in question are both—
(i) participators in C, and
(ii) employees of, or office-holders in, C, and
(b) the number of other persons who at that time are both—
(i) employees of, or office-holders in, C or, if C is the principal company of a trading group, any member of the group, and
(ii) connected with persons within paragraph (a);
NE is the number of persons who at that time are employees of C or, if C is the principal company of a trading group, any member of the group.
(6) The participators in C who are referred to in subsections (2) and (5) do not include any participator who—
(a) is not beneficially entitled to, or to rights entitling the participator to acquire, 5% or more of, or of any class of the shares comprised in, C’s share capital, and
(b) on a winding-up of C would not be entitled to 5% or more of its assets.
(7) In this section—
(a) “participator” has the meaning given by section 454 of CTA [Corporation Tax Act] 2010, and
(b) references to a participator in a company are, in the case of a company which is not a close company (within the meaning of Chapter 2 of Part 10 of that Act), to be construed as references to a person who would be a participator in the company if it were a close company.
That’s a lot of text, with big words and legal-speak! A key point to note is when the word “and” is used, vs “or”. This seemingly minor change can have a significant impact. Here is a breakdown into (what we hope) is plain English so that you can apply it to your situation.
236N (1) to (3)
Starting with the top section, the key things to note are:
1) You must meet the 40% test for 12 months before the EOT sale
This is Condition A. The company can’t have exceeded the 40% ratio at any point in that year.
2) You must meet the test through to the end of the tax year of the sale
That’s Condition B. However, this legislation has been superseded by a policy change announced in the October 2024 budget. It states that the period when EOT companies need to meet the key criteria post sale must end four years following the end of the tax year in which the EOT gains a majority stake. So while 236N(3) suggests you only need to meet the criteria until the end of the tax year of sale, this is no longer correct.
236N (4)
This clause offers some ‘wiggle’ room. It allows your company to temporarily breach the ratio, for less than 6 months, as long as the reasons are outside your control.
Here’s how this would work in practice for a company that has two participators and five employees, so just meets the 40% test.
- If an employee resigns or dies and is replaced within six months, you would pass this test. The employee left for reasons ‘outside your control’, and the breach was short term.
- If an employee resigns or dies, and it was more than six months before another employee was recruited, you would not pass this test. Whilst the employee still left for reasons ‘outside your control’, the breach was longer term.
- If an employee is fired, and replaced within six months, you would not pass this test. Whilst the breach is short term, you chose to fire the employee, so it was ‘in your control’. Potentially if the trustees didn’t have control over the firing process, you might try to justify you met this test, but we wouldn’t want to try to argue that!
236N (5) – How to work out the numbers in the fraction
Before diving into the details, it’s worth noting that the same person can appear on both sides of the fraction; as a participator in the top half and as an employee in the bottom half.
“NP” (top half of fraction) - total number of participators(5)(a)
The top of the fraction includes people who are:
- a participator, and an employee or an office holder (i.e. director/company secretary)
If you have an “angel investor” who bought shares but isn’t employed or on the board of the company, then they would not count here, irrespective of their shareholding. Potentially this could include a family member who acquired some shares years ago but has no active role in the business.
(5)(b) But then you need to add anyone who is:
- an employee or an office holder, and connected to one of the participators above.
This mean employees who are related to shareholders. For this purpose, family members includes:
- spouses/civil partners
- children (and grandchildren/further lineal descendants)
- parents (and grandparents/further lineal descendants)
- siblings
- nieces/nephews
- aunts/uncles
- spouses/civil partners of any of the above
- any of the above relatives of your spouse/civil partner
On rare occasions, weddings can cause problems here... as whilst two people are “just dating”, they’re not connected. But the second they get married, they are officially connected. So if your company is borderline, keep an eye on office romances!
Be aware that while for some other purposes connections like aunt/uncle/niece/nephew are too remote to count, but our understanding is 236U(3) makes clear that those relations do count as connected for working out the participator ratio. However, more distant relations, such as cousins, or great aunts/uncles, do not count for this purpose.
“NE” (bottom half of fraction) – total number of employees
This is more straightforward to work out. It’s simply the number of employees in your company. This includes anyone on the payroll and includes:
- Part-time workers
- Casual workers only used at certain times
- Employees on zero hours contracts (as long as they’re on the payroll)
It doesn’t include:
- Freelancers
- Contractors
When the holding company of a group is transitioning to an EOT, employees in all group companies count.
Overseas employees count here too. There are no stipulations in the legislation that says they cannot be included in the calculation. So as long as they are genuinely employed and on the payroll, you they can be added to this part of the fraction.
It is our understanding that these international employees are also entitled to a share of profits, just like UK employees. However, you would need to check tax laws in their country of employment to see if there was any equivalent to the £3,600 tax free break.
236N (6) – The exception
The rule states you can ignore someone if they:
- own less than 5% of any class of shares, and
- would receive less than 5% of assets on a winding-up
In our experience, with small companies this rarely occurs.
How it helps
5% is a low threshold (when we’re talking about a small company)
The most common situation, in which someone will own (or have the right to own) less than 5%, is when share options have been offered to a few employees. If these share options are for the same ordinary share capital as other shareholders, this exclusion should prevent all these option holders counting as participators.
Where it causes issues
Often, when share option schemes are set up, they will be for a new, different class of share. There are many reasons for setting up shares this way, such as so the holders have different voting or dividend rights, or they are “growth shares” with a “hurdle price”.
For example:
Four employees are given options to acquire “B” shares. These shares only reflect 4% (1% each) of the overall value of the company. However, if the other shareholders hold “A” shares (a different class) it means these four employees are the only ones with any rights to the “B” shares. This means they each have rights to 25% of that share class. 25% is of course not less than 5%, so those employees would now count as participators.
This quirk often catches well-meaning founders out. What began as a way to bring employees into the business by offering a modest stake accidentally makes it much harder to sell to an EOT later on.
Example participator ratio calculation
Scenario
- Joe and Jane own 50% each of JB Ltd.
- Jane is full-time on JB Ltd’s payroll and a director.
- Joe works elsewhere, but is company secretary of JB Ltd.
- The company employs seven people in total. Four full-time including Jane, three part-time including Jane’s nephew.
Who counts in NP?
- Jane – she’s a shareholder and on payroll
- Joe – he’s a shareholder and an office-holder
- The nephew – he’s employed and connected to Jane
NP = 3
Who counts in NE?
Everyone on the payroll counts, regardless of their hours.
NE = 7
Participator ratio is 3/7 = 43%. JB Ltd fail the test.
Potential solutions:
- Remove Joe as company secretary. NP falls to 2 and the ratio becomes 2/7 = 29%
- Hire one unrelated employee. NE increases to 8, ratio becomes 3/8 = 38%
- Ask the nephew to leave. NP falls to 2, NE also falls to 6, ratio becomes 2/6 = 33%
Any one of these solutions brings the ratio under 40%. Remember, the company needs to be beneath the 40% ratio for at least the 12 months before the sale to an EOT and beyond. So JB Ltd would need to make one of the above amendments, then wait at least 12 months, before then selling.
Plus, even if in this example JB Ltd was currently just the right side of the ratio (i.e. 40% or under), they’d need to look back 12 months, and sanity check it’s consistently been the case. If for example they’d only recently taken on 1-2 new (unrelated) employees, then whilst they might meet the ratio today, they still may fail this test if they sold to an EOT tomorrow.
Common scenarios clarified
In the examples below, someone might not seem to be a participator, but the situation means that they count in the NP figure for the participator ratio.
Inactive shareholder
We have five shareholders. My partner and I own 70% of the company and are full -time directors. Three other people own 10% each. Of those, one is on the payroll, one is a non-exec director, and one isn’t either (just a silent shareholder). Do they count?
Yourself, your partner, plus two of the 10% shareholders count. Whilst all five shareholders will meet 236N(5)(a)(i), the 10% shareholder who isn’t either on the payroll or an office holder won’t meet 236N(5)(a)(ii). Both (i) and (ii) need to apply to be included in the top half of the fraction.
Family members
I own 100% of the company. My spouse is on the payroll, providing part-time admin support throughout the year. My cousin works full-time, heading up the sales department. My niece also occasionally helps out in school holidays and gets a modest sum via payroll. Which of these count?
Yourself, your spouse, and your niece count. Your cousin doesn’t. The hours worked aren’t relevant here. All that’s relevant is that they’re on the payroll, and the family relationship is close enough to count as connected for this purpose. Cousins are distant enough to not count. Your spouse and niece are close enough that they do.
EMI option holders
My partner and I own 100% of the company, but we’ve recently issued EMI share options to five senior employees. In practice, even if they exercise the options, it will only account for around 2% of the company each (10% between them). But to make it more affordable for the staff, we made these growth shares, with a hurdle price equal to current business valuation, so they only benefit from a future sale at above current value. This means they’re “B” shares, different to the shares my partner and I own. Do they count?
Yes. Whilst their future ownership may be modest in real terms, and currently they own nothing, you have given them each the right to own 20% of the B share class. That is sufficient for all five of those staff to count in the top half of the participator ratio. It’s also worth checking whether any of the other employees are connected to those five employees too.
If these EMI option holders had the right to acquire a similarly modest stake, but of the ordinary share capital (same as the main shareholders), then they would not have counted. They would have just 2% of the share class and would meet the less than 5% of any share class exception in 236N(6).
Corporate shareholders
XYZ Ltd owns 20% of the company and is a corporate director. Does it count?
We don’t believe a corporate entity counts in NP. A corporate shareholder can be an office holder (companies can be directors), but 236N(5)(a) states “the number of persons who…”. This suggests that companies would not count. However, other legislation refers to “natural persons”, which normally means a human being. Other legislation also refers to “legal persons”, which normally would include Limited Companies. Unhelpfully here they’ve neither included “natural” nor “legal”, so we can’t be 100% sure.
Owners of corporate shareholders
XYZ Ltd owns 20% of the company being sold to an EOT. XYZ Ltd itself is owned 50:50 by two people, who are both directors and employees of XYZ Ltd. Neither of them own any direct stake in the company being sold to the EOT, only the indirect stake via XYZ Ltd (indirectly owning 10% each). One of them is a director of the company being sold, the other isn’t. Do these individuals count?
No, they will not count. Although one is a director of the company being sold and indirectly owns a 10% stake, our understanding is because they do not directly own any part of the company being sold, they would not count.
Summary
The participator ratio sounds simple at first glance – a fraction with a 40% threshold. But add in some family connections, share options or inactive shareholders and it can quickly become very complex.
Want to check whether your business meets the participator ratio and other key EOT eligibility tests? Use out EOT explorer to find out. This free, online tool that includes an eligibility checker, business valuation and some questions about your mindset to help you work out whether an EOT is viable for you and your business.