Who wants to be an employee shareholder?
In late 2012, the Government held a consultation into the employee shareholder concept. Despite some negative publicity, employee shareholder status passed into law with effect from 1 September 2013.
Much of the commentary on the new status has focussed on the perceived negative aspects, but there are also some significant opportunities to take advantage of this new status, particularly when it comes to rewarding key employees.
Becoming an employee shareholder
An individual can become an employee shareholder if he enters into an agreement with his employer to acquire the new status and pursuant to that agreement:
- he is issued shares with a value of at least £2,000 by his employer for which he gives no cash or other consideration; and
- he agrees to waive certain employment rights, including the right to receive a statutory redundancy payment and the right not to be unfairly dismissed in circumstances which are not automatically unfair.
Tax implications
The introduction of employee shareholder status coincided with the introduction of various tax reliefs designed to make the new status more attractive.
In summary, the key tax advantage for the individual is that the first £50,000 worth of shares issued (valued at the time of issue) will be exempt from capital gains tax on a future disposal of those shares. If the company grows significantly, this could prove to be a very valuable relief. The downside is that the individual will be subject to an immediate income tax charge (and possible NICs) on the value of the shares received, except for the first £2,000 of such value.
The employer company will be entitled to claim a deduction for corporation tax purposes to the extent of the value of the shares allotted to the individual (including the first £2,000).
So why all the criticism?
The general reaction from most commentators is to question whether as little as £2,000 worth of shares is worth giving up the relevant employment rights. Note that the shares do not have to be ordinary shares – they can be a new class of heavily restricted shares. There are also some practical consequences which need to be considered.
Tax Planning Opportunities
To illustrate how the employee shareholder status may be of significant benefit, we have looked at two circumstances in particular – other circumstances may become apparent as the rules ‘bed in’.
Firstly, as the following example demonstrates, the new status could be used to benefit certain key employees in a tax efficient manner if a sale is on the cards.
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Example ABC Ltd is worth £1m and the shareholders are considering marketing for sale. However, they would like to reward a key director with a share of proceeds. The director agrees to become an employee shareholder in exchange for 5% of the shares. On the basis that no sale is agreed, the value of 5% is reduced by a minority discount of say 75% to £12,500 and the director pays income tax of £4,200 on the issue of the shares. When the company is eventually sold for £1m, the director receives a £50,000 share of the proceeds on which he pays no tax as the gain is exempt. Factoring in the income tax paid, his net receipt is £45,800. By contrast, if the shares are issued for nil cost under a tax advantaged share scheme such as the Enterprise Management Incentive Scheme, the director would have paid income tax of £5,000 and capital gains tax of £2,660 assuming at least 12 months have passed so that he qualifies for entrepreneur’s relief. Without this relief, the capital gains tax increases to £7,448. Either way, the director’s net receipt is markedly reduced. |
Secondly, it will be worth considering employee shareholder status in start-up situations, where there is a close-knit team of founding individuals. At this stage, the value of the company will be minimal so any income tax charges will be small and the potential to benefit from the capital gains exemption will be tremendous if the company succeeds.
Summary
Although the above is an overview only and there are certainly employment law issues to be considered, the new employee shareholder status is certainly a valuable option to be considered by any employer looking to make arrangements for certain employees to obtain shares in the company. The key to gaining maximum benefit from employee shareholder status will be acting quickly and in the earliest stages of any start up or preparations to market a company for sale.
If you would like to know more about employee shareholder status and how it can work for your company, please contact Nicola Hewitt on 0114 266 7171 or nicola.hewitt@bhp.co.uk.
