tUESDAY, 9 OCTOBER 2012

 

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 UK Tax Law Update

 

"Employee Owners" Scheme - another government attempt to foster an equity culture

 

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For additional information please contact:

Nick Thornton
Partner

+44 20 7862 4612  
nthornton@orrick.com 

Chris Grew
Partner
+44 20 7862 4763 
cgrew@orrick.com 

Will Gay
Managing Associate
+44 20 7862 4762 
wgay@orrick.com 

Giles Hawkins
Senior Associate
+44 20 7862 4780 
ghawkins@orrick.com 

James Lindon
Share Schemes Specialist
+44 20 7862 4718
jlindon@orrick.com
 

 

 

The Chancellor recently announced an outline plan to enable “employee owners” to receive shares with the benefit of zero capital gains tax in exchange for accepting reduced statutory employment rights.

Whether these will be sufficiently attractive carrots to employee and employer to justify diversion from the well-trodden path for emerging companies of granting simple and highly flexible Enterprise Management Incentive (“EMI”) options remains to be seen.

Our initial reaction is that we haven’t seen enough as yet to justify deferring proposed EMI option grants back to the anticipated “go-live” date of next April, but we will update you when more detail is made available.

The key points are:

  • Under a new type of contract, employees (“employee owners”) would be “given” between £2,000 and £50,000 of shares. In exchange, employee owners would lose their statutory rights on unfair dismissal, redundancy, and the right to request flexible working and time off for training, and will be required to provide 16 weeks’ notice of a firm date of return from maternity leave, instead of the usual 8 weeks.
  • Current employees could also be moved onto employee owner contracts, but couldn’t be forced to do so. New hires could be offered employee owner status or conventional contracts at the employer’s discretion.
  • Companies of any size would be able to use this new kind of contract. (This differs from EMI, which is restricted to smaller companies, with fewer than 250 full-time equivalent employees and no more than £30m of balance sheet assets.)
  • Companies recruiting employee owners would continue to have the option of inserting more generous employment conditions into the employment contract if they wanted to. As such, it seems that if an employer wants to offer the tax benefit without (wholly or partly) the loss of employment rights it is free to do so.
  • Employee owners would pay 0% capital gains tax on gains on the disposal of shares awarded as part of their contract. They would also be eligible for existing employee share ownership schemes such as the EMI. (Gains on EMI options are taxed as capital gains rather than employment income, giving favourable tax results.)
  • The Government will consult on details of the contract later this month, when more detail will hopefully be given. Draft legislation is due later this year, with the “go-live” date being April 2013.
  • The Government consultation will apparently include details of restrictions on forfeiture provisions to ensure that if an employee owner leaves or is dismissed, the company is not able simply to take the shares back but is able to buy them back at a reasonable price. (This seems more restrictive than the approach usually adopted by employers on employee shares, as typically employees who leave through their own choice or as a result of misconduct - “bad leavers” - will not be entitled to receive more than they paid for the shares when leaving.)

Obvious immediate questions are:

  • Can share awards vest over time or according to performance, or will employee owners become 100% vested on day one? The latter would clearly be unattractive to founders. To date HM Revenue & Customs approved share schemes have permitted (or sometimes required) an element of deferred vesting in order to encourage employee loyalty.
  • Must “bad leavers” also be entitled to a reasonable price on leaving? Again that would seem unattractive. It may be that the government intends to specify permissible “good leaver” / “bad leaver” provisions, but on this we can only wait and see.
  • What will the income tax treatment of “giving” the shares to an employee owner be? Will that trigger an income tax charge on day one, as seems likely? That would be potentially problematic. The government’s intention here is simply unclear.
  • What will the valuation base be for the £2,000 minimum value requirement? For many start-ups, the £2,000 threshold could lead to individuals ending up with significant stakes in the business. There may be a tension with companies wanting to obtain a low valuation for EMI purposes but needing to show a higher value to get more employees into “Employee Owner” status. Obtaining a low share valuation at the time options are being granted is a key element of maximising the benefit of EMI option grants for employees, so this may be a more significant issue in practice than those developing this policy understand. 

We will monitor developments.

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