On 8 October 2012 the Chancellor announced a new proposal to encourage employees to give up employment rights in exchange for shares, the so-called Employee Shareholder Status (Shares for Rights) proposals. New and existing employees of any size of company may be “given” between £2,000 and £50,000 of shares “that are exempt from CGT” – but not, it seems, exempt from income tax on acquisition.
On 18 October 2012, the Department for Business, Innovation and Skills (BIS) launched a consultation on a new employment status, “employee owner” (in addition to the two existing statutory statuses of employee and worker).
The consultation states that its aim is to give businesses greater choice about the contracts they can offer to individuals, while maintaining appropriate levels of protection. This is part of the government’s review of employment laws “to ensure they maximise flexibility for both parties while protecting fairness and providing the competitive environment required for enterprise to thrive”. The consultation sought views on how the government should implement this new status in practical terms and the implications for employers, individuals, and the labour market in general. In particular, government wanted to identify unintended consequences.
The consultation focused mainly on the employment law aspects of the proposals, and did not address the tax issues in any detail. HM Treasury is consulting separately on the tax aspects of the proposals.
If the Employee Shareholder Status (Shares for Rights) proposal is to be successfully implemented, a number of important issues will need to be addressed:
As employees are to be charged to income tax on the initial value of the shares, thought must be given as to how the tax will be funded. If the shares are “readily convertible assets”, the tax will be due under PAYE, and attract NICs.
What price is to be ascribed to the surrender of employment rights? Will there be a ‘standard tariff’? An employee of a larger quoted company might be enticed to forgo his rights in exchange for, say, £10,000 worth of shares, but how does this compare with an employee of a smaller unquoted company asked to forgo a similar level of employment security, but for shares with an initial value that might, on ordinary valuation principles, be of substantially lesser value? To what degree is it appropriate – or possible – to factor in any “hope value” when valuing shares for these purposes? The initial value of shares in a start-up company may be close to zero : is it right that an employee forgo his employment rights in exchange for such a speculative investment?
How will the shares be valued? If the normal bases of valuation are used, the shares in a small privately-held company may be of relatively low value allowing relatively large holdings in smaller ‘start-up’ companies to be acquired at a low initial cost. In effect, this would appear to be, in part, a means of extending the EIS scheme to employees who are not directors – but without the up-front relief from income tax.
There must, presumably, be restrictions upon the type of shares to be used. It would otherwise be all too easy to offer a form of “growth share” which would allow the employee to secure disproportionate growth in value with full CGT relief. Conversely, shares of a class with undue restrictions might allow unscrupulous companies to entice employees to forgo employment rights in exchange for shares which prove to be relatively worthless. If the company has third party investors and multiple classes of shares then, presumably, the shares to be used will need to be “ordinary” shares with rights which are no less favourable than those attaching to any other class of shares. Could the shares used be of a class which has more favourable rights than those attaching to shares held by other non-employees?
Details of restrictions on forfeiture provisions to ensure that an employee who leaves or is dismissed may be obliged to offer back the shares “at a reasonable price”. It appears therefore that obliging employees to offer shares for sale on leaving will be permitted, but only on the basis that the price at which the shares are sold must be not less than their “market value” – given that, unless and until any person is able and willing to buy shares in the company, or the company is floated on a public market, the value of a small minority holding in an unquoted private company affording no element of control or influence, is worth “little to man or beast”, one can envisage a pressure to dismiss all those employees holding such shares in advance of an “exit event”, simply to allow controlling holders to increase their stake at little cost. The natural uplift in value, from “minority interest” basis, to “pro rata” basis which accrues upon a sale of the whole of the issued share capital would then be lost to those former employee-owners. It is difficult to see how to protect against such ‘abuse’.
How will the taxation of the shares fit within the existing tax regime for employment-related securities? If the shares cannot rank as “restricted shares subject to a short-term risk of forfeiture”, then it will not be possible to defer any “up-front” charge to income tax on their initial market value, as would normally be the case (in the absence of a tax election under s431 ITEPA 2003). In any event, if the up-front charge is deferred, there will be a subsequent income tax charge which will detract from the benefit of the CGT exemption.
The use of share options appears to be ruled out, although the announcement refers to participating employees remaining eligible to be granted EMI options (if the company and the individual qualify).
As can be seen from this handful of initial comments, to become a workable arrangement, which does not allow for misuse or abuse, will require much thought and engagement with all interested parties.
The government will use the Growth and Infrastructure Bill to amend the Employment Rights Act 1996 to create this new employment status. The associated capital gains tax exemption will be legislated as part of the Finance Bill 2013.
Companies will be able to use the new type of contract from April 2013.