Employee-shareholder status: More trouble than it's worth?

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On the day of the Autumn Statement the Government released its response to the consultation on the new employee-owner status (now to be called employee-shareholder). The response gives the impression that the Government are 'pushing ahead' with the new status regardless of the comments received on the consultation, the greater proportion of which were negative.

In summary, the employee-shareholder status will be a new employment statusunder which the employee gives up certain employment rights (most significantly, the right to claim unfair dismissal unless the claim involves discrimination) in return for the employer giving the employee shares worth at least £2,000. The disposal of the shares given under this status will be capital gains tax exempt.

This article provides views on the employee-shareholder status from the perspectives of specialists in Blake Morgan in the areas of taxcompanyand employment.

Tax

The original suggestion was that the value of the shares that could be given under this new status would be limited to £50,000 worth of shares. There will no longer be a limit on the value of the shares which can be given, although it will only be the first £50,000 worth of shares that will benefit from the capital gains tax (CGT) exemption on a future disposal.

The response to the consultation recognises the potential issues with valuing the shares for these purposes, but suggests that all the answers will appear in the guidance on the status which is currently unpublished. Given that the status is still set to be introduced from April 2013, we would hope to see the guidance published imminently.

One of the criticisms of the status from a tax perspective was that the individual would have a tax bill (income tax and national insurance contributions (NICs) on the gift of shares) at a time when they may not have the cash to fund the bill. The Government propose that the first £2,000 worth of gifted shares may be exempt from income tax and NICs. We will need to wait to see what the Governments' final response to this is, although the first £2,000 being income tax and NICs free does not help those being gifted shares of a greater value who will have a higher tax bill.

The biggest potential problem from a tax perspective does not seem to have been dealt with in the response to the consultation and this is that not every disposal of shares by a shareholder who is an employee is subject to capital treatment. If there is no capital treatment then the CGT exemption has no value. We will need to wait for the draft legislation and guidance to be produced to see to what extent these concerns are resolved.

In summary from a tax perspective, whilst the CGT exemption is potentially a valuable exemption, many of the complicated issues need to be addressed before it is possible to really consider this as an alternative option for employees.

Company

On the face of it the proposed new employment status of 'employee-shareholder' may seem an employer friendly package. And yes; employers will benefit from a reduced employment rights legislation burden and enjoy greater flexibility when dealing with employee shareholders whilst getting such employee shareholders to financially invest in the business. However, because of the rapid introduction of the legislation, the lack of detail around it and the availability of viable alternatives in terms of providing tax efficient methods of incentivising staff with shares, it is hard to envisage a huge take up of this new status, by either employers or employees when it comes into effect.

The main complaints made in the response to the Government consultation were centred around the following practical aspects:

  1. restrictions on shares – employers and employees are likely to view this differently with employees wanting no restrictions on share rights and employers will want to retain flexibility and have the ability to negotiate with the employees as to any restrictions as part of a commercial arrangement. Unsurprisingly, the Government's stated intention is to not place any restrictions on the shares
  2. forfeiture of shares – again, employers and employees are likely to have polar opposite views here with employers wanting any forfeiture terms to be subject to negotiation on an individual basis. Employees will be keen to secure the best forfeiture terms possible if they are indeed, forced to sell the shares back to the company for any reason, after all, they are giving up employment rights in the first place in order to get the shares. The Government has confirmed its belief that this should remain a contractual arrangement between the parties
  3. valuation of shares – the high cost and timing of any necessary share valuation will cause an issue for both employers and employees. The Government has promised to explore various options around this area but again, employees are going to be concerned that they are not selling their shares for a reduced rate because the company has chosen to terminate their employment at a time when the share price may be artificially deflated.


Added to the above, the potential negative reputational effect on employee relations, perceived increase in related legal, tax and accounting costs and a heightened risk of employer/employee disputes will surely dissuade all but perhaps an aggressive fast growth start up company from offering this equity linked employment status to potential and existing employees. Even then the general uncertainty and confusion of this 'third way' in employment status may prove too unappealing to small businesses or first time employers to engage in.

Employment

The fact that on this occasion business groups and employers were largely against the employee-shareholder proposals is striking. From an employment law perspective, one of the main concerns is that preventing employee-shareholders from claiming unfair dismissal and removing certain other rights will provide little comfort to employers that opt for the new status.

Under the draft legislation, employee-shareholders will not be prevented from bringing any claims on the grounds of discrimination (relating to sex, race, disability, age, pregnancy and maternity, sexual orientation, religion or belief, marriage and civil partnership and gender reassignment). Being unable to request flexible working is also a potential red herring: a woman who has been prevented from working flexibly is already more likely to bring a sex discrimination claim than a claim regarding her right to request flexible working. Nor does it prevent claims that a dismissal is automatically unfair, of which there are many kinds, including dismissals related to whistleblowing, a transfer of undertakings (TUPE), taking family leave, raising a health and safety complaint etc. For this reason its attraction to employers will be limited.

For employees the question is whether the shares they receive will be worth the sacrifice of their rights, particularly in relation to unfair dismissal and redundancy pay. In order to give up most statutory employment rights (via a compromise agreement), an employee is required to take independent legal advice on what that means. It is somewhat surprising that these rights could be lost without the employee-shareholder having to take legal advice.

The Government response to many concerns like this is that it will provide guidance, but that is not the same as tailored legal advice. Moreover, at the start of the employment relationship it is all but impossible to know what the potential value of employment rights could be, depending as they do on factors which are all determined around the time of dismissal: length of service, age, seniority, the reason for dismissal and other surrounding circumstances. It is these factors which enables both parties to take a commercial view when assessing the value of those rights under a compromise agreement. By contrast the value of the rights a potential employee-shareholder will be giving up are completely unknowable. Even the promised Government guidance cannot assist with the question, 'is this a fair deal?'. And while it will be 'voluntary' for existing employees to accept or reject the new status, jobseekers may find themselves with less choice.

Clearly senior executives will be able to a) afford to get legal advice and b) ensure that their contractual rights (eg long notice periods) provide adequate protection. Junior and more vulnerable employees with less bargaining power are inevitably likely to come off worse and fall prey to unscrupulous employers. As many have pointed out, the 'John Lewis' model of ownership is laudable, but that does not involve the sacrificing of employment rights, and this new employment status is in danger of giving bad press to the whole concept of employee ownership.

For further information on employment law aspects please contact your Vigil adviser. Please note that this may fall outside the scope of Vigil's day-to-day advice.