The government has published a consultation document on implementing its proposal to introduce the new employment status of 'employee owners'.

In summary, the proposal:

  • will enable companies to offer between £2,000 and £50,000 of shares that are exempt from capital gains tax in exchange for employees surrendering various employment rights, including those regarding:
    • unfair dismissal;
    • redundancy;
    • the right to request flexible working;
    • time off for training; and
    • rights in relation to return from maternity leave (women will have to give 16 weeks' notice of their date of return from maternity leave); and
  • allows companies to offer this type of contract to new employees only, although it will be optional for existing employees.

While the proposals are aimed at fast-growing small and medium-sized companies, the ability to offer employee owner contracts will be available to companies of all sizes. Large companies with a significant number of employees may see this as an ideal opportunity for potentially limiting future costs and the proposals may be of particular interest to companies held within private equity structures where the initial share price is low, but where there is potential for significant share price growth.

At this stage, limited details have been given on critical issues, such as:

  • whether companies will be required to determine the level of award based on pre-determined factors;
  • the type of share that may be issued; and
  • whether sale restrictions or forfeiture provisions can be imposed if the employee leaves or is dismissed.

These issues form part of the government consultation. Whether the company can simply take the shares back or is obliged to buy them back at a reasonable price is fundamental to the reasonableness of this proposal. The probable outcome is that employees will be required to sell back their shares at a fair price on leaving the company. This raises significant issues for unlisted companies (eg, those owned through a private equity structure). If such companies will be required to undertake a share valuation every time that an employee leaves, the cost is likely to be prohibitive.

Similarly, while generous capital gains tax relief is central to the proposals, the announcement is unclear as to whether the shares will be treated as granted for free (and thus subject to upfront income tax) or whether the employee will be treated as providing value in the form of his or her waiver of employment rights. Income tax charges on shares in unlisted companies pose particular problems. Without such income tax relief, the benefits for employees receiving awards at the lower end of the scale are limited – there would need to be significant share price growth for such employees to exceed the current capital gains annual exemption of £10,600. However, a nil rate of capital gains tax is an improvement on the current 10% rate under entrepreneurs relief, with potentially fewer conditions to satisfy, and could thus result in greater interest in structuring deals to take advantage of this.

The consultation period closed on November 8 2012, with the proposal due to come into force in April 2013.

Separately, as part of the government's wider consideration of the benefits of employee share ownership in the private sector, the Department for Business, Innovation and Skills has published both its response to the Nuttall Review on employee ownership and, as a part of its response, a consultation paper on deregulating share buybacks, including draft regulations.

For further information on this topic please contact Andrew Taggart at Herbert Smith Freehills LLP by telephone (+44 20 7374 8000), fax (+44 20 7374 0888) or email (andrew.taggart@hsf.com).

This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.