The Chancellor, George Osborne, yesterday announced radical plans for employees to give up some of their statutory employment rights in exchange for shares in the business they work for. Any gain made on those shares on a subsequent disposal would be tax free; although there could be an upfront income tax and NICs charge at the point the employee acquires the shares.
Under the proposals, employees would enter into an owner-employee contract, whereby they will receive between £2,000 and £50,000 of shares. Any gain on those shares on a subsequent disposal by the employee would not be subject to capital gains tax. In exchange for the shares, employees will be required to give up their UK employment rights on:
- unfair dismissal;
- the right to request flexible working and time off for training; and
- will be required provide 16 weeks’ notice of a firm date of return from maternity leave, instead of the usual 8.
Although the new owner-employee status will be optional for existing employees, employers can insist on owner-employee contracts for new hires once the legislation introducing the concept comes into force in April 2013. Whilst the owner-employee concept is principally intended for start-ups and small and medium sized companies, it may be used by companies of any size.
While the legislation to bring in the new owner-employee contract will come later this year so that companies can use the new type of contract from April 2013, the Government will consult on some details of the contract later this month.
Amongst other things, the Government consultation will include the details of restrictions on forfeiture provisions to ensure that if an owner-employee leaves or is dismissed, the company is not able simply to take the shares back but is able to buy them back at a reasonable price.
Much of the media focus has been on the capital gains tax exemption available on any gain in the shares following disposal by an owner-employee. However, it needs to be borne in mind that where an employee acquires shares by virtue of his employment and pays less than the market value for those shares, there is likely to be an upfront income tax and NICs charge. It is unlikely that employees, other than the better paid, will be in a position to either fund this upfront tax charge or have the available funds to pay market value for the relevant shares.
Employment Law Implications
Employees giving up their statutory rights at the commencement of employment would involve a radical culture change in employee relations. Where employees have to agree to this (ie existing employees), employees are likely to want to ensure that the value of any shares is at least comparable to the protection they are losing. Given that unfair dismissal awards can potentially be in excess of over £85,000 (although in practice these are much lower) it seems likely that employees will only agree to the new contracts if the shares have appreciable value. Where employees do not have to agree to the terms, ie they are new employees, then they may simply not take up the job offer because they are worried about loss of protection, and employers may wish they had never gone down that path.
Given the potential upfront income tax and NICs charge coupled with the forfeiture of valuable employment rights in exchange for a speculative capital gains tax saving, it remains to be seen how popular the owner-employee concept proves to be.
The owner-employee concept also fails to appreciate the commercial reality that many employee shareholders, other than senior employees, do not pay capital gains tax anyway by virtue of the annual capital gains tax exemption which is currently worth £10,600.
The proposals also raise interesting questions about the interaction between the capital gains tax exemption for owner-employees and other reliefs, most notably entrepreneurs’ relief. It remains to be seen what the consultation concludes, but there may be an incentive for companies and senior employees to structure arrangements such that there is no longer any need to meet the more stringent criteria to benefit from entrepreneurs’ relief.
Subject to the consultation and draft legislation, there may be further planning opportunities for senior employees. By virtue of their bargaining power, senior employees, may find themselves in a position able to concede the relevant statutory employment rights such as unfair dismissal and redundancy in order to benefit from the capital gains tax exemption whilst maintaining the necessary employment security through the form of contractual protections such as payment in lieu of notice clauses and liquidated damages provisions. Whilst this would not be in the spirit of what is intended, depending on the final form of the legislation, it may well be an unintended consequence.
At this stage no action is required on the part of employers and it is prudent to wait until further details are published by the Government, although we are aware of some clients who have sent a communication to employees affirming their desire to maintain employment rights.
For the HM Treasury press release, please click here.