Offering an equity stake in the business can be a beneficial way of attracting and retaining employees as well as having some tax benefits. In the Autumn the government announced their proposals for new employee shareholder status. The idea is that the employee gives up some of their employment rights and in return the employer can provide some shares with a tax break. This is a new concept for both employers and employees.
This new employee shareholder status will be enacted by The Growth and Infrastructure Bill 2013 which is currently being debated in the House of Lords. It is expected that the new status will be available from 6 April 2013.
In return for the employees giving up certain employment rights they can acquire shares in their employing company and any future gains will be exempt from capital gains tax. The draft 2013 Finance Bill published on 11 December 2012, included draft capital gains tax legislation relating to the CGT exemption.
Capital gains tax exemption
Under an ‘employee shareholder agreement’ an employee is offered shares in the employer company or an associated company (another group company or a company under common control) which have a minimum value of £2,000. The consideration for the shares is the entering into of an employee shareholder agreement. Under that agreement the employee relinquishes certain employment rights.
There is no limit on the value of the award but the CGT exemption is only available on shares with an initial value of up to £50,000. Gains on shares in excess of this are subject to the usual CGT rules. As the CGT exemption only applies to shares which have a market value of less than £50,000, at the date they are issued. While this makes the scheme attractive for start-up businesses these businesses could struggle to meet the £2,000 minimum threshold.
The shares will not be eligible for the CGT exemption if the shareholder or a connected person has a material interest in the company or its parent at the date the shares are issued or at any time in the previous 12 months. A material interest exists where the individual has at least 25% of the voting rights in the company or its parent. This share incentive is not intended for founders and major owners of the business.
In the absence of any clear definition of “connected person” we can assume that the normal interpretation for CGT provided at s286 TCGA 1992 would apply which would include any relative.
There are specific rules which determine which employee shareholder shares are treated as exempt where the number of shares issued or allotted on a day takes the recipient over the £50,000 limit. The special share pooling arrangements will also be amended in respect of the employee shareholder shares to allow an employee who holds both exempt and non-exempt shares of the same class, to determine what proportion of exempt shares are treated as being disposed in a part disposal situation.
The draft legislation also contains provisions which disapply the rollover rules of s127 TCGA 1992 applying on a share exchange or reorganisation of share capital.
There are currently no restrictions on the type of company which can qualify for the new arrangements. It is our understanding that companies of any size will be able to use the new status and offer shares to employees. Non UK registered companies can also benefit from the new rules.
There is no working time restriction on employees or restrictions on the type of shares which can be offered to the employee. It will be possible to have shares with restrictions such as no voting rights, limited rights to income etc. Such restrictions would be taken into account when valuing the shares.
Other aspects of the new arrangements
Relinquishing employment rights
In exchange for the CGT exemption an employee will forgo certain employment rights. The Government intends to amend the Employment Rights Act 1996 to create a new employment status, ‘employee shareholder’ thereby giving employers an additional contract to choose from. If this new contract is offered and the employee accepts it in exchange for the shares, the employee will forgo the following employment rights:
- Unfair dismissal rights (except for reasons that are automatically unfair or that relate to discrimination);
- The right to statutory redundancy payments;
- Certain rights to request flexible working and time to train;
- Requirement to provide 16 weeks’ notice on returning from maternity leave instead of the current eight weeks.
All other employment rights will remain intact.
There appear to be some inconsistences in what method to adopt for valuing the shares when determining if the limit is met. The 2013 Finance Bill states that the value at all times shall be the unrestricted market value (UMV) at the date of issue. This is which is in line with the rules for EMI share options. This is the price that the shares might reasonably expect to fetch on the open market ignoring all restrictions.
Practitioners will be aware of the difficulties and the cost associated with valuing shares in private companies. Although this issue is still under consideration there does not appear to be any special valuation process for these shares and the value will still be open to HMRC scrutiny for tax purposes.
The actual market value (AMV) and UMV of the shares will have an impact on the income tax position of the employee as outlined below and in terms of the CGT exemption it is important that employers have certainty that the shares allotted do have an initial value of at least £2,000. If an employee can show that they received shares worth less than £2,000 the employee would be able to challenge the employment shareholder status in an Employment Tribunal something employers will be keen to avoid.
Income tax charges
Where shares are acquired by reason of employment it is not only CGT that employees have to consider. Under the employment related securities rules (ERS) income tax charges can arise where shares are acquired at undervalue. At present there is no relief from the income tax charges. This would make these arrangements unattractive especially for the more junior employees who would be faced with having to meet an upfront tax charge as well as giving up some employment rights.
There is an added complication where shares carry restrictions as the initial income tax charge would be based on the AMV. The employee in most cases is likely to enter into a joint s431 ITEPA 2003 election whereby the employee is deemed to have acquired the shares at UMV. By making the election it ensures that any future growth in the shares falls within the exempt CGT regime rather than giving rise to further income tax exposure. The cost in making the election is that the upfront tax charge is likely to be higher.
Where shares are readily convertible assets for example shares issued in a subsidiary company the amount chargeable will be also be subject to NIC and is payable along with the tax under PAYE. This accelerates the payment date and increasing the exposure for both employee and employer.
On the upside, the employing company would be entitled to a corporate tax deduction usually based on the amount chargeable to income tax on the employee.
The government are considering providing an exemption from income tax for the first £2,000 of shares but to date this has not been confirmed. Whatever the final outcome, it is highly unlikely that a full income tax exemption will be available so this up front tax charge would have to factored into the decision in taking on this new shareholder status.
Employers will need to consider whether the new employee shareholder status will be attractive to the types of employees it is trying to recruit and retain. The scheme may be attractive to skilled senior employees who are willing to forgo employment rights in exchange for a stake in a growing business. The scheme itself may be a suitable alternative to a highly restricted approved share option scheme allowing many more employees to obtain shares. However, the prospect of an upfront income tax charge coupled with the loss of certain rights may make this unattractive to many employees.
Further updates on this new status will follow once all the final details have been agreed. In the meantime if you have any queries on the new employee shareholder status please call TaxDesk on 0845 4900 509 and ask for Martin Mann.