On 8 October 2012, the Chancellor, George Osborne, announced proposals for a new type of employment status, under which employees (“employee shareholders”) would forfeit some of their employment rights in exchange for shares in their employer. Any growth in value of the shares would be exempt from capital gains tax (CGT).
The stated aims of the Government’s employee shareholder proposals are to “improve the effectiveness and flexibility of the labour market” and to encourage businesses to recruit.
Unfortunately, few practitioners seem convinced that these objectives will be achieved – or that the proposals are even necessary. That dubiousness now appears to be shared by the House of Lords, as on 20 March peers backed the amendment to the Growth and Infrastructure Bill removing the clause on employee shareholders. 232 voted for its removal as against 178 to retain it. Shadow Treasury spokesperson Lord Adonis told the House: “I don’t think I’ve ever witnessed a government policy with less support”. (He also called the proposals a “totally mad idea” and “ill thought through, confused and muddled”.)
Despite this defeat (and despite 92% of respondents to the Government consultation viewing the plans in a negative or mixed way), the Government may well press ahead. This is, after all, a pet project of the Chancellor. Furthermore on the return to the House of Commons of the Growth and Infrastructure Bill, the House of Lords’ changes can be overturned and recent reports suggest that the House of Commons has done precisely that and reinstated the proposals.
Operating on the assumption that the proposals will become reality, as they are now timetabled to do on 1 September 2013, what do they entail?
The devil in the detail: overview of the proposals
The brief original Treasury and BIS press release states:
• The new employment contract will be available for all companies, but is principally intended for fast-growing SMEs that want a flexible workforce.
• Under these contracts, each employee will be “given” shares worth between £2,000 and £50,000 that will be exempt from CGT (employee shareholder shares).
• In exchange, an employee shareholder will give up their UK rights relating to:
– protection against unfair dismissal;
– redundancy; and
– the ability to request flexible working and time off for training.
• In addition, employee shareholders will need to give 16 weeks’ notice of a firm date of return from maternity leave rather than just 8.
• Employee shareholder status cannot be imposed on existing employees.
• New employment may be offered exclusively on an employee shareholder basis if the employer wishes.
• Employers can offer employee shareholders more generous employment terms if they wish.
• Employee shareholder shares will attract full CGT relief and continue to be eligible for existing statutory tax-favoured employee share ownership schemes, including EMI options.
At the report stage and third reading of the Growth and Infrastructure Bill further amendments were proposed which include:
• Restricting the right of employee shareholders returning from parental leave to make a formal request for flexible working to the period of 14 days beginning with their return.
• A power to make secondary legislation to regulate the terms on which companies can buy back employee shareholder shares when employee shareholders change status or leave.
• Protection for existing employees against detriment or dismissal if they refuse to become employee shareholders.
Tax and National Insurance implications
The 2013 Budget included further details about the tax treatment of employee shareholder shares. At last the income tax position has been clarified, with confirmation that legislation will be introduced to prevent an income tax charge on a buyback of CGT-exempt employee shareholder shares.
The relevant income tax and National Insurance contributions (NICs) legislation will be amended to deem, for tax and NICs purposes, that an employee shareholder pays £2,000 for their employee shareholder shares. These changes will eliminate income tax liabilities on acquisition for employee shareholders receiving the minimum value of employee shareholder shares (assuming that the employee does not enter into a section 431 election to tax the unrestricted value of the shares when acquired, if they are restricted securities).
However, by extension it seems clear that there will be an income tax liability for employee shareholders who acquire shares worth more than £2,000. Any tax liability on acquisition will be payable through PAYE, with associated NICs liabilities, if the shares are readily convertible assets.
Draft clauses related to the income tax and CGT treatment of employee shareholder shares will be included in the Finance Bill 2013 (but were not yet available at the time of writing this article).
The employee shareholder tax provisions are expected to come into effect on 1 September 2013, at the same time as the Growth and Infrastructure Bill which introduces the employee shareholder employment status.
Proposals under the microscope
Questions which immediately spring to mind in relation to the proposals include the following:
1. Why would any individual swap potentially valuable employment rights for shares when there may be no obvious market for those shares and hence their saleability (and hence the price that might be capable of being achieved for them) might be limited?
2. Valuation of company shares is already a complex issue, often requiring expensive professional expertise and negotiation with HMRC. How attractive is the employee shareholder regime in reality, if employers are going to need regular share valuations, not only for initial acquisitions, but for buying back shares from leavers and keeping employee shareholders informed and engaged?
3. Generally speaking, any sensible company puts in place good and bad leaver provisions in their articles of association which dictate the value a departing shareholder receives for their shares if they leave employment – are such provisions going to be acceptable under this regime? If not, then is the arrangement not unpalatable for employers? If they are to be permissible, is the arrangement not also unpalatable for employee shareholders? Obviously the revisions to the Growth and Infrastructure Bill, as referred to above, provide that secondary legislation may be enacted to address this area but there are no firm proposals as yet about this.
4. Given the company law limitations on the ability of private companies to buy back their own shares, won’t the employer need an Employee Benefit Trust for this purpose, to provide a market for the shares? Is this not an additional layer of complication and cost that will make the arrangement even less attractive for many SMEs?
5. How many potential employee shareholders are going to want to pay to take advice on the drafting of the potentially complex documentation governing their holding of shares? If they don’t take advice, how many disputes are going to arise when they exit the company and are disappointed about how little they get back?
6. How much satellite litigation will be created by such an arrangement being put in place? Disputes over status, over discrimination and automatic unfair dismissal claims (both being classes of protection which employee shareholders will retain and hence issues are likely to be “shoe-horned”, however spuriously, into those categories), over the value of the shares and ability of the employer to claw them back are all time-consuming and potentially costly. Many employers might prefer the (relative) certainty of the established case-law pertaining to “normal” employees rather than the yet-to-be developed principles surrounding employee shareholders.
7. Given the proposed income tax treatment, only individuals being “gifted” the minimum value of shares will avoid a charge to income tax. As things stand there are no plans to mitigate the income tax position for those receiving more than £2000 worth of shares. So depending on the value of the shares (and hence the quantum of the tax charge) are such shares not a “gift” that you have to pay for?
8. Is the decision to restrict employee shareholders’ access to maternity rights and flexible working not in direct conflict with the Government’s advertised commitment to family-friendly policies?
The CIPD has observed that unfair dismissal protection “doesn’t figure in the list of top ten regulations discouraging employers from recruiting staff”. In which case, aren’t these proposals unnecessary? They have significant, complex (and potentially costly) implications for employers and employee shareholders alike, including an array of legal, tax and accountancy issues. A Government truly committed to a reduction in red tape would not have tabled these proposals – or at least would have attributed proper weight to the negative feedback arising out of the (all too short) consultation.