Since 1 September 2013, employers have had the option to offer new and existing employees employee shareholder status.
What is employee shareholder status?
Employee shareholder status is a new employment status, introduced on 1 September 2013. An employee shareholder is an employee who has given up certain employment rights in return for shares worth at least £2,000 (at the time that they are acquired) in either their employer or their employer’s parent company. There is no cap on the number of employee shareholder shares that an employee can receive, but the capital gains tax exemption on disposal of the shares is restricted (see below).
What rights must an employee shareholder give up?
Under the terms of an employee shareholder agreement, an employee shareholder will give up their statutory rights in relation to:
- unfair dismissal;
- a statutory redundancy payment;
- requesting flexible working; and
- time off for training.
Employee shareholders will also be subject to stricter maternity and other family rights (being required to give 16 weeks’ notice of their firm date of return from maternity, paternity, additional paternity or adoption leave instead of the usual 8 weeks).
An employee shareholder’s right to claim automatically unfair dismissal (e.g. in relation to health and safety issues or whistleblowing) or under the Equality Act 2010 for unlawful discrimination is not affected.
Can employees or potential employees be required to become employee shareholders?
No – an individual cannot be required to accept employee shareholder status if he/she does not wish to do so. If an existing employee refuses to accept an offer of employee shareholder status, the employee has the right not to be subjected to a detriment by the employer as a result. Employees will be considered to be automatically unfairly dismissed if the reason for the dismissal is that they refused to accept an offer by the employer to the employee to become an employee shareholder.
Can all employers offer the new employee shareholder status?
Companies of any size, whether established companies or new start ups, can choose to offer an “employee shareholder” type of contract to new and/or existing employees. As employment rights are given up in exchange for shares, only employers that are companies limited by shares can offer employee shareholder status. The employer company can be a UK registered company, a European company (Societas Europaea) or an overseas company.
What are the benefits of being an employee shareholder?
The employee shareholder will not be subject to income tax or national insurance contributions on acquisition of the shares, if the shares are only worth £2,000 and the individual does not have a material interest of more than 25% in the company. However, if the shares are worth more than £2,000, an income tax charge will arise on the balance. National insurance contributions may also be payable. For the purposes of the £2,000 test, the value of the shares is the actual market value, taking any restrictions into account.
The employee shareholder will not be subject to capital gains tax on any gains made on disposal of the employee shareholder shares. If an employee shareholder acquires employee shareholder shares which are worth more than £50,000 on acquisition, the exemption will only apply on disposal of the first £50,000 of shares. Again, an important condition is that the employee shareholder and connected persons cannot have a material interest in the company. For the purposes of the £50,000 test, the value of the shares is the market value ignoring any restrictions.
Where employee shareholder shares are bought back from an ex-employee by the company, the individual will not be subject to income tax on the purchase price. Subject to the £50,000 limit, there will be no capital gains tax charge on the buyback either.
What conditions must be met for employee shareholder status to apply?
The employer must give the employee shareholder a written “statement of particulars” of the status of employee shareholder and of the rights which attach to the “employee shareholder shares”. This must state:
- the employment rights that the individual will give up;
- the notice periods that would apply in the individual’s case (16 weeks instead of 8 weeks to return early from maternity, paternity, additional paternity or adoption leave);
- whether any voting rights attach to the employee shareholder shares;
- whether the employee shareholder shares carry any rights to dividends;
- whether the employee shareholder shares confer any rights to participate in the distribution of any surplus assets on a winding up;
- if the company has more than one class of shares and any of the rights referred to in paragraphs (c) to (e) attach to the employee shareholder shares, how those rights differ from the equivalent rights that attach to the shares in the largest class (or next largest class if the class which includes the employee shareholder shares is the largest);
- whether the employee shareholder shares are redeemable and, if they are, at whose option;
- whether there are any restrictions on the transferability of the employee shareholder shares and, if there are, what those restrictions are;
- whether any of the requirements of sections 561 and 562 of the Companies Act 2006 (existing shareholders’ right of pre-emption) are excluded in the case of the employee shareholder shares; and
- whether the employee shareholder shares are subject to drag-along rights or tag-along rights and, if they are, explain the effect of the shares being so subject.
The individual must receive advice about the terms and effect of the proposed agreement from an independent legal adviser. The advice may be from a solicitor, barrister, legal executive, union official or advice centre. The employer must meet the reasonable costs incurred in receiving this advice, regardless of whether the individual actually becomes an employee shareholder. Payment of such legal costs by employers will not be a taxable benefit for the individual concerned. However, the cost of obtaining tax advice is only excluded from being a taxable benefit if the advice is only an explanation of the tax effects of employee shareholder agreements generally.
In addition, an individual agreeing to the offer will be entitled to a seven-day “cooling off” period from the day legal advice is received, even if the agreement has already been signed by the parties.
No indication has been given as to what constitutes “reasonable costs” for the advice. However, given that advice seems to be required on employment, taxation and also the shares themselves, the costs may well be at a higher level than the contribution which employers often make towards the legal fees of an individual entering into a statutory compromise agreement on termination of employment.
The company does have full discretion to determine what restrictions the shares will have, if any, and there is no obligation on the company to buy back shares. There will be costs for many companies though in amending their articles of association or putting in place restricted share agreements to provide for those restrictions on employee shareholder shares, as well as any provisions for compulsory transfer of employee shareholder shares when an employee shareholder leaves (see below).
It is also important to note that the shares must be issued by the company fully paid. The Department of Business, Innovation and Skills (BIS) has confirmed that, as the company must not accept anything from the employee shareholder in return for the shares (apart from them agreeing to enter into the employee shareholder agreement), companies will usually have to capitalise reserves and may also need to amend their articles, in order to be able to issue the shares fully paid as a bonus issue. BIS has also stated that the company’s accounts will need to record that the company has paid for the shares in full.
What happens if the employee shareholder leaves the company?
The employee shareholder may keep the employee shareholder shares unless the company’s articles of association (or the employee shareholder agreement) require him or her to sell them on departure.
Companies may wish, therefore, to amend their articles to provide for compulsory transfer of employee shareholder shares when an employee shareholder leaves. The shares could be purchased by the company or by other employees. If the price cannot be agreed, these provisions may require the shares to be independently valued.
Unfortunately, the company cannot use shares transferred by a departing individual (or shares held in an employee benefit trust or held by the company in treasury) as employee shareholder shares for a new employee shareholder. Employee shareholder shares can only be issued. Once they are transferred they lose their tax benefits.
It is also worth noting that, if an employee shareholder is permitted to sell employee shareholder shares whilst remaining employed, their employment status does not change: the individual remains an employee shareholder.
Is HMRC approval required?
No, it is not necessary for either the employer or employee to seek approval from HMRC before entering into an employee shareholder agreement. However, HMRC provides a facility for agreeing the market value of the shares for employee shareholder agreements in the same way that they agree market values for share plans such as Enterprise Management Incentive (EMI) options. This is not compulsory, but is advisable for both the employing company and the employee shareholder as it provides certainty. The costs of undertaking a valuation of the shares (when the shares are allotted and potentially again if they are bought back by the company) may prove to be prohibitive for many smaller companies.
In terms of timing, the majority of rights which an individual would agree to forgo in order to become an employee shareholder, including the right to claim unfair dismissal or a statutory redundancy payment, require at least two years continuous employment. Any benefit therefore to an employer of an individual waiving those rights prior to two years’ service is somewhat marginal. Such status could be offered as a carrot at, perhaps, the end of a probationary period or after the accrual of two years’ service.
The employee shareholder status has been developed as a combination of employee equity incentives and a reduction of employment rights. In some cases the equity incentive and potential tax advantages may not outweigh the reduction in employment rights (or implementation and valuation costs for employers). In other cases, perhaps at a more senior level, the balance might swing the other way.
How we can help
Implementing employee shareholder status will be a complicated process. Companies will need to follow a procedure set out in the Growth and Infrastructure Act 2013 and take advice on employment law, company law and tax law.wIf the process is not correctly followed, the individual may be able to claim that he or she was not an employee shareholder but an employee with the usual employment rights.