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Employee Shareholders - UK Capital Gains Tax Exemption for Employee Shares




by:
Shawn E. Atkinson
Michael McCormack
Andrew Overend
David Ramm
Edwards Wildman Palmer LLP - London Office

 
October 3, 2013

Previously published on October 2, 2013

On 1 September 2013, the Growth and Infrastructure Act 2013 (the GIA) came into force in the UK bringing with it a new statutory employment status, namely the ‘employee shareholder’. The GIA provides that, through agreement with his employer and for no financial consideration (although significant employment rights must be given up), an employee shareholder can receive new fully-paid shares worth up to £50,000 in the company that employs him (or that company’s parent undertaking) which will be exempt from any capital gains tax on future sale. Although the capital gains tax exemption only applies to the first £50,000 of employee shareholder shares, there is no maximum value set for shares that may be issued under an employee shareholder agreement. There is, however, a minimum value of £2,000 of employee shareholder shares which must be issued to any new employee shareholder.

Alongside the other taxation reliefs available to key employees in high-growth industries such as entrepreneurs’ relief, the employee shareholder scheme offers significant taxation benefits for employee shareholders and will have particular benefits for management teams in private equity buy-outs.

How to use the employee shareholder scheme

To become an employee shareholder, the employee will have to give up the following employment rights:

  • statutory unfair dismissal rights (except dismissal for automatically unfair reasons, where dismissal is in breach of the Equality Act 2010, and dismissal in relation to health and safety);

  • rights to statutory redundancy pay;

  • the right to request flexible working (except in the 14 days following return from parental leave); and

  • certain statutory rights to request time off to study or to train.

An employer and an individual need to take the following steps before they can enter into an employee shareholder agreement:

  • although there is no prescribed form of employee shareholder agreement set out in the GIA, there is a requirement that the company must provide the individual with a ‘written statement of particulars of the status of an employee shareholder’ (information on what this written statement must include can be found here);

  • the individual must seek independent advice on the contents of this statement of particulars (the cost to be borne by the employer, regardless of whether the individual subsequently declines the offer); and

  • the employee must be given a 7 day ‘cooling-off’ period to consider the offer; only once this cooling-off period has passed can the agreement be entered into.

There is also no requirement in the GIA section (currently) that the employer or the employee need notify HMRC of the entry into any employee shareholder agreement, however employers who have awarded employee shareholder shares will need to provide details on HMRC Form 42 (Employment-related securities) at the end of the relevant tax year.

New vs existing employees

Companies may choose to establish recruitment practices which will require acceptance of an employee shareholder agreement for all new employees going forward. However, companies cannot compel existing employees to enter into an employee shareholder scheme.

Taxation

The most significant tax relief provided under the new employee shareholder scheme is that shares allocated under the scheme (up to a £50,000 limit) are exempt from capital gains tax (CGT) on disposal. Importantly, the £50,000 limit is assessed at the point the employee shareholder shares are acquired by the employee shareholder, not when they sold on. The explicit intention behind the relevant section of the GIA is stated by BIS to be to benefit small and medium enterprises that are keen to grow their businesses without impacting their cashflow. It is our view that it will also be very beneficial for management teams in private equity deals who may wish to become employee shareholders to benefit from the CGT exemption referred to above.

Additionally, the scheme has been implemented so that income tax and National Insurance contributions will not be payable on the first £2,000 of the share value received by an employee shareholder. HMRC guidance highlights that normal rules on income tax will apply to shares given to employee shareholders beyond that £2,000 share value. As the employee shareholder is always deemed to have given £2,000 (and no more) consideration for the shares, in the event the shares’ market value is in excess of £2,000, this excess will be chargeable to income tax because these shares will have effectively been issued at an undervalue.

Significantly, the tax exemptions referred to above will only be available to those employee shareholders who do not have a ‘material interest’ in their employer or its parent undertaking. For these purposes an individual will be judged to have a material interest in a company if he (together with any connected persons) can exercise at least 25% of the voting rights. Further, to benefit from either of the exemptions, an individual cannot have held a material interest in the calendar year before becoming an employee shareholder; and cannot hold, or be entitled to obtain, rights to a material interest.

For increased certainty as to the amounts which may potentially become chargeable to income tax (on acquisition) and potentially to CGT (on disposal), companies are permitted to submit a proposed valuation to HMRC’s Share and Assets Valuation Team in advance of the allotment of employee shareholder shares. The valuation agreed with HMRC will be the value ascribed to any awards of employee shareholder shares for a 60 day period following the date of the agreement.

Summary

  • In our view, senior executives are likely to see the most benefit from CGT exemption on the sale of the first £50,000 worth of shares allotted under the scheme as the potential gain on their shares may be substantial. Management teams with significant bargaining power may also seek to negotiate contractual provisions that effectively replace the statutory protections they would give up by becoming employee shareholders. Additionally, junior employees may be more concerned about the loss of their statutory employment rights and are less likely to be able to negotiate changes to standard form employment contracts.

  • Given that the income tax exemption relates only to the first £2,000 of share value received by an employee shareholder, this saving is not likely to be particularly attractive to junior employees who may not wish (or be able) to pay substantial income tax amounts; especially considering the availability of other approved employee shareholder schemes (e.g. EMI schemes).

  • Before adopting any policy of requiring employee shareholder agreements to be entered by new employees, companies should carefully consider the value of any such mandatory (rather than voluntary) programme set against any potential reputational damage that may come from engaging in a scheme where employees are asked to give up significant statutory employment rights.

  • Any good leaver/bad leaver provisions in any shareholders agreements and/or articles of association are likely to be scrutinised more than ever. We believe particular issues that are likely to arise include: the meaning of ‘unfair dismissal’ in a leaver scenario; and whether the company, in circumstances where an employee shareholder is compelled to sell their shares, is required to repay any income tax paid by that employee shareholder on the earlier acquisition of their shares.



 

The views expressed in this document are solely the views of the author and not Martindale-Hubbell. This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.
 

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