Employee Shareholder Status (Shares for Rights)
Please note that the Autumn Statement 2016 announced the removal of all tax reliefs for “employee shareholder” shares (“ESS”). This will take effect where the employee shareholder agreement has not been entered into before 1 December 2016, or, where independent advice was taken on 23 November before 1.30pm, before 2 December 2016. Whilst this deadline applies to the removal of all tax relief for ESS, the Government has indicated its intention to remove employee shareholder status at the earliest opportunity.
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“Employee shareholder” shares (“ESS”) were introduced in 2013 as an initiative by the Government to aid small businesses and start-ups in creating a more flexible workforce. Essentially, they allow companies to award at least £2,000 of shares to their employees on tax-advantaged terms, in exchange for the employee giving up certain specified employment rights.
As a form of statutory employee share incentive, ESS has benefits for both employers and employees, and it is often used with an eye to incentivising employees rather than reducing the protections available to them.
The main employment rights which must be surrendered in exchange for an ESS award include the right to bring a claim for unfair dismissal (other than on automatic grounds – i.e. the employee can still claim for dismissal on discriminatory grounds or in relation to health and safety) and the right to statutory redundancy pay. Other rights that are given up relate to flexible working, time off to train and the time period in which an employee must give notice of an intention to return from parental leave.
Tax Treatment of ESS Awards
The basic tax treatment of an award of ESS shares is no tax (or NICs) paid on the first £2,000 of shares awarded and no capital gains tax paid on the first £100,000 of gain in value, as long as the shares were worth no more than £50,000 at the time the award was made. The cap of £100,000 on gains for which CGT was available was introduced in March 2016; CGT relief was previously unlimited (and continues to be unlimited for awards made before that date).
It is worth being aware that if the employee meets the qualifying requirements for Entrepreneurs’ Relief – in particular, they must hold at least 5% of the ordinary share capital of the company – this can be used together with ESS, so that gains which do not qualify for the ESS exemption from CGT may still be taxed at the 10% ER rate. However, the CGT relief that normally applies on a reorganisation of share capital may not be available for ESS shares.
Requirements for making ESS awards
There are a number of requirements applying to ESS awards however, compared to other statutory share schemes, the requirements for ESS are relatively flexible. In particular, ESS awards may use shares in a subsidiary – which means companies which would not ordinarily be able to use other forms of statutory share scheme may still often qualify for ESS.
Key issues are, however, that the ESS shares must be newly issued by the company, and that the employee cannot give any payment or “consideration” for their shares other than the agreement to give up the specified employment rights. There are a number of key questions relating to this requirement that we will need to consider with you.
Another point to be aware of is that ESS awards must use shares in either an employee’s employer company, or a direct parent of that company – the awards cannot use shares in another group company, even if they are clearly part of the same corporate group.
Need for independent advice
An unusual aspect of ESS awards is that the employee must receive independent professional advice at their employer’s expense, in order to ensure they understand the rights they are giving up. This must be given at least seven days in advance of the employee entering into an ESS agreement.
Share awards will only qualify for ESS tax treatment if they are worth at least £2,000 at the time of grant. The tax due on ESS shares, both on award and on sale, will be determined by reference to their initial value so it is key to be certain of this at the time the award is made. The value of ESS shares may be agreed in advance with HMRC and we recommend that this be done in all cases.
ESS and Growth Shares
ESS awards are often made over some form of “growth share” – that is, a special class of share which participates in the value of the company only above a hurdle. The nature of these shares is that they have little value at the time of award, but may, if targets are met, become more valuable in the future.
Growth shares are a useful incentive for employees of private companies, as they give employees the opportunity to share in value to which they contribute, while from the shareholders’ perspective, employees will only receive anything if they manage to increase the value of the company for all shareholders. The advantages of using them with ESS are:
- The tax benefits of ESS fit neatly with growth shares, as there is limited income tax relief on award, but more valuable CGT relief in relation to growth in value; and
- ESS allows the value of growth shares to be confirmed with HMRC, which, as set out above, is vital to determining their tax treatment. In particular, this is an advantage in relation to awards of growth shares as HMRC will in practice otherwise be free to argue later that the value of shares should have been treated as higher for income tax purposes – i.e. that income tax was underpaid.
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