Trading employment rights for equity: a new tax efficient way of giving shares to UK employees
It has long been believed that increasing employee equity participation and deregulating the labour market can be important drivers of economic growth, but few people expected a policy that would combine the two. However, that is what happened in October of last year, when the UK government announced that it would allow employees to give up certain employment rights in exchange for equity in their employer. Although the proposals were met with overwhelming criticism both from politicians and the business community, the government managed to get the legislation through parliament and it finally became law on 1 September 2013.
The legislation creates a new category of employee, called an ‘employee shareholder’. To become an employee shareholder, an individual must be given at least £2,000 worth of shares in their employer for free. In return for those shares, an employee shareholder will not have certain employment protection rights (such as the right to claim unfair dismissal and the right to redundancy pay). Employers will not be able to force their current employees to accept employee shareholder status, but it may be imposed on new employees. It is also available to overseas parent companies who wish to give shares to employees of UK subsidiaries.
There are also some potentially valuable tax breaks:
- income tax and social security will not be payable on the first £2,000 worth of shares
- no capital gains tax will be payable on shares worth up to £50,000 on acquisition
What are the likely obstacles?
For companies that already offer equity participation to their employees, this legislation appears to provide an attractive alternative, or addition, to the existing equity compensation package. However, there are a number of obstacles to be overcome, primarily concerning the valuation of the shares and the tax treatment.
- The shares must be worth at least £2,000, so getting the valuation right will be crucial. If the shares are worth less than £2,000, the employee will still have the employment rights and none of the tax breaks will be available
- For smaller companies, £2,000 worth of shares may be a significant percentage of their share capital
- Although the capital gains tax exemption is available for shares worth up to £50,000, income tax (and possibly social security) charges will still be due if the shares are worth more than £2,000. It will therefore be unattractive to employees who have to fund those tax charges themselves without being able to realise value from the shares
In addition, companies intending to implement employee shareholder status across the workforce will need to carefully consider the employee relations issues and the message they are trying to convey. Is this about involving employees in the future of the business through equity ownership or, as some more sceptical employees may believe, a way of doing employees out of their statutory employment rights on the cheap? It is not difficult to imagine situations in which employees are made redundant and not only do they receive no redundancy payment but their shares are also worthless.
Other tax advantaged equity arrangements in the UK
For a number of years, employers in the UK have been able to offer shares to their employees that enjoy tax advantages. For smaller companies, the Enterprise Management Incentive (EMI) plan is very popular and it provides similar tax benefits to the employee shareholder legislation but without the practical difficulties. There are a number of other tax advantaged schemes, such as the Company Share Option Plan, Share Incentive Plan and Save-As-You-Earn plan, and recent and proposed changes in legislation will make it much simpler to operate such plans. Therefore, for companies that wish to offer equity participation to their UK employees and who are not concerned with taking away employment rights, the existing tax advantaged plans are likely to be the preferred route.
Conclusion - an opportunity for executive remuneration packages?
The aim of the legislation was to create a more flexible workforce for small fast growing companies, but it is feared that the take-up from such companies will be low due to the practical difficulties involved. However, a lot of companies, both large and small, will be looking at the opportunities the legislation presents for the tax efficient structuring of executive remuneration packages. Typically, more senior employees would not be as concerned with the loss of unfair dismissal and redundancy rights due to the other contractual protections they enjoy. In addition, they are more likely to be willing to bear any upfront tax charges that arise, taking into account the longer term tax advantages arising from the capital gains tax exemption.
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