What about the workers?

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Chancellor of the Exchequer George Osborne on October 8 canvassed the idea of increasing employees’ involvement in their companies when he announced a proposal for an ‘employee-owner contract’. This was to be backed by the incentive of capital gains tax exemption on profits on the sale of the shares which the employee-owners acquire in their employer company. However it would be subject to a quid pro quo that an employee-owner would lose certain employment rights. 

This concept moved a step further on 18 October when the Department for Business, Innovation and Skills (BIS) initiated a consultation on employee-owner status. Although it appears primarily to cover employment law matters it seems that this subject may have an impact on companies but potentially not on company law. The consultation states that BIS do not propose to make any amendments to the Companies Act 2006 to make special provisions for the new employee-owner status and even asks if respondents have any comments on this. It may be that some existing employee share schemes will have to be adapted for employee owner shares. 

The consultation makes for interesting reading but, as far as this writer is concerned, it is highly repetitive and has the hallmarks of being put together very quickly. Paragraphs 9 to 11 make the following essential points:

  • the government will introduce a new employment status in which employee-owners will not have all the employment rights of an employee but will have shares in the company they work for; any gains on those shares will be exempt from capital gains tax 
  • companies of any size will be able to use this new status (but it is principally intended for fast-growing companies that want to benefit from the flexibilities available through the new status) 
  • employee-owner status has two defining characteristics: an equity share and different employment rights 

So companies with a proven track record are not the main target, but rather ‘fast-growing companies that want to benefit from the flexibilities available’ (and whose share value may of course be highly debatable).

The consultation pumps on that any gain on the shares (however large) linked to the status will be exempt from capital gains tax (CGT) on increase in the shares. But this may be a sleight of hand as the annual CGT exemption is currently £10,600 per person so that an employee-owner would clearly have to sell a lot of the relevant shares to be chargeable anyway (and could of course spread the sales over a period of years to enjoy the annual exempt amount each year). The proposed CGT exemption for employee-owners thus implies that relatively senior (and presumably well paid) employees may be the only ones affected if they would otherwise be chargeable to CGT beyond the annual exempt amount. For other employee-owners, who are probably exempt from CGT on threshold grounds, they are in effect being ‘incentivised’ to give away valuable employment rights in return for being given shares. (The consultation does not mention them being required to buy the shares.) The consultation admits that if employees are given the shares they will be subject to income tax and national insurance contributions (NICs) under the general rules that apply for shares acquired by reason of employment (and the consultation states that such shares will not be eligible for the Enterprise Incentive Scheme, or any tax-advantaged employee share scheme). This makes the incentive appear even less attractive as the net benefit after deduction of up-front tax and NICs is related to shares which may be difficult to value in a private ‘fast growing’ company and on which for most owner-employees the sole advantage of CGT exemption is illusory. 

What kinds of shares are involved? According to para.11 of the consultation, one of the characteristics of employee-owner status is that they receive ‘equity’ shares. These are described in para.16 as: ‘all types of shares will be eligible … These shares may carry rights to dividends, voting rights, or rights to a share in the company’s assets if it is wound-up. The government expects that this will take effect as part of a contractual arrangement between employer and the employee owner’.

The company would not unfairly be allowed to place forfeiture restrictions on the shares, so that in accordance with common practice in employee share schemes, the employer company would be allowed to include a clause in contracts requiring the employee to surrender the shares when the employee left the company, was dismissed or made redundant. On the other hand, if the shares were surrendered, the employer would have to buy them back at a reasonable value (see para. 16 and 17.)

On valuation, the consultation states that the shares would be valued according to their unrestricted market value at the time that they were awarded as the price that the shares might reasonably expect to fetch on the open market, disregarding any restrictions. The consultation admits that valuing company shares may present difficulties in certain cases, particularly for unquoted companies, and it is keen to ensure that this new employment status does not impose any valuation requirements beyond those that already exist when valuing companies for other tax purposes. Further valuations may be required in relation to forfeiture and buy backs and for any tax requirements. It does not state who will meet the valuation costs. 

The government intends to bring forward legislation to effect this measure via the Growth and Infrastructure Bill. The associated CGT exemption will be legislated as part of the Finance Bill 2013 and the intention is to operate employee-owner status from April 2013. Is this indecent haste?

© Thomson Reuters (Professional) UK Ltd
Extracted from Sweet & Maxwell’s Company Law Newsletter, Issue 324, 23 October 2012 and reproduced with kind permission of Thomson Reuters (Professional) UK Ltd.

 

 

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