Employee shareholder status

The Growth and Infrastructure Act 2013 introduced 'employee shareholder' status whereby employees give up certain employment rights for shares.

1 September 2013 saw the implementation of the Growth and Infrastructure Act 2013 introducing the new 'employee shareholder' status whereby, broadly speaking, employees give up certain employment rights for shares. Whilst it is meant to encourage employees to have a vested interest in the business, owning a stake, Labour has already said they will scrap the status if they win at the next election - is this really going to be attractive to anyone other than high earning individuals seeking to benefit from the capital gains tax (CGT) exemption?

Who is the new status aimed at?

The new employee shareholder status is aimed at:

  • Companies (not LLPs/partnerships)
  • Fast-growing SMEs
  • Highly skilled employees who are mobile in the jobs market
  • High earning managers seeking to benefit from the CGT exemption on disposal who can afford the up front tax costs in acquiring shares in the employer company
  • Companies working towards an exit
  • Employees who move jobs frequently and who are unlikely to achieve 2 years service

Consequences of employee shareholder status

The employee shareholder has to receive fully paid up new issue shares for free with a value of no less than £2,000 on the date of issue (there is no maximum value of shares that can be given by the employer company). They do have to be new issue shares so they cannot be transferred from an existing shareholder or an EBT.

The key advantage to the employee shareholder is the CGT exemption - shares with a value of £2,000-£50,000 on the date of issue will be exempt from CGT on disposal.

In accepting shares and becoming an employee shareholder, the individual can be required by the employer to give up the right to:

  • Request time off to undertake study/training
  • Request flexible working (except shortly after returning from parental leave)
  • Not to be unfairly dismissed (unless automatically unfair or discriminatory)
  • Statutory redundancy payment
  • Notice needed to give before returning to work after maternity, parental, paternity or adoption leave increased to 16 weeks (compared with 8 weeks for employees)

These are the maximum rights that an employer can ask the employee shareholder to give up and the employer may decide to allow the employee shareholder to keep some or all of these rights (without prejudicing the key benefit, the CGT exemption, that comes with employee shareholder status). Whilst these rights can be given up by an employee shareholder, employers need to be particularly careful that their actions could not be argued to be discriminatory in any way, particularly on the basis of sex, as this will still entitle the individual to bring a claim.

A summary of the legal requirements to have employee shareholder status

As detailed above, the employee shareholder has to receive fully paid up new issue shares for free with a value of no less than £2,000 on the date of issue. The shares do not need to be ordinary shares and they can be restricted (in terms of voting rights, dividend rights, rights on liquidation and on exit).

The employer company has to issue a written statement of particulars to the employee shareholder which will detail:

  • the employment rights (as set out above) that the employee shareholder is required to give up by the employer
  • the rights attached to the shares they will receive such as voting rights and rights to dividends
  • any restrictions on the transferability of the shares
  • whether the shares are subject to 'drag along' and 'tag along' provisions

The employee (or applicant) has to receive independent legal advice (ILA) on the legal documentation paid for by the employer. PLCs need to bear in mind the rules relating to 'financial assistance' in paying for the ILA (as paying the costs of ILA is financial assistance in relation to the acquisition of shares which is, prima facie, unlawful).

Once the employee/applicant has received ILA, there is a strict 7 day cooling off period before they can receive the shares and become an employee shareholder. If this timetable is not complied with, even if just by one day, the individual will be an employee (with full employment protection) and a shareholder.

Dismissal and detrimental treatment for refusing to become an employee shareholder will be automatically unfair. Employers also cannot impose the status on existing employees without their consent although an employer can make job offers conditional on the applicant agreeing to become an employee shareholder.

What documentation is required?

  • Contract of employment: In addition to the written statement of particulars, companies need to issue a contract of employment to the employee shareholder in the ordinary way.
  • Articles of association: The articles of association of the employer company (Articles) should be amended to incorporate compulsory transfer provisions should the employee shareholder cease to be involved in the company with an appropriate valuation mechanism (possibly good/bad/early leaver provisions as would be incorporated with 'normal' employees who are shareholders). Employers should not assume that they can get the shares back if the employee shareholder were to leave – they cannot unless there are appropriate provisions in the Articles. If a different share class has been created, or if the shares are restricted in any way (e.g. non voting shares) then this will be detailed in the Articles. Limitations on share transfers and further share issues will be included in the Articles. Finally employers need to include 'drag along' provisions so that if the majority shareholder wanted to sell, he could compel the minority employee shareholders to sell also ('tag along' rights may be included but these are for the benefit of the minority shareholders).
  • Shareholder Agreement: A shareholder agreement may set out the key decision making process (so the Company can make key decisions without the need for all shareholders to consent), dividend policy and restrictive covenants. As the employee shareholder will be an actual owner of the business, it is arguable that an employer could justifiably argue that it is reasonable for covenants to be for a longer period of time as they are not 'just' an employee but an actual shareholder.

Key advantages for businesses

Clearly this is another additional option to help employers recruit, retain and incentivise. The status gives employers some certainty against litigation (although employers need to be particularly careful that their actions could not be argued to be discriminatory in any way as this will still entitle the individual to bring a claim). The minimum share value of £2,000 is quite low compared with the employment rights relinquished. Shares can be restricted (so they don't have to carry an entitlement to vote (for example)) and the Articles can be drafted such that compulsory transfer provisions apply if an employee leaves (with a reduced valuation if desired).

The key advantage to employees is the CGT exemption on disposal of shares with a value of £2,000-£50,000 on the date of issue.

Any key disadvantages?

For companies:

  • The professional costs of implementation may be disproportionate
  • Share valuation is difficult in private companies and all employers should be encouraged to get their accountant to agree the share value with the Share Valuation Division at HMRC (not least because if the employer issues shares worth less than £2000, the individual will be an employee (with full employment protection) and a shareholder)
  • The status is likely to be unpopular with high-quality female applicants/employees due to inflexible working/notice of return to work following maternity leave rules
  • Employers cannot contract out of discrimination laws so it is easy to see how an individual could try and argue discrimination to get around the fact they have contracted out of unfair dismissal protection - particularly in ignoring requests for flexible working and in adopting dismissal procedures
  • The impact of TUPE transfers is not yet known
  • Denying employment rights may reflect badly on an employer's reputation
  • For start-ups, £2,000 may represent a significant percentage of the share capital based on the relevant value
  • The status is not available to many in family businesses due to the connected person rules
  • If companies rapidly grow, employee shareholders may leave early, realising accumulated tax-exempt gains, getting increased employment rights/shares elsewhere

For employees, the key disadvantage is the upfront PAYE/NIC charge on the shares they receive for free (as the shares are a taxable benefit), giving them a day one tax charge which many employees would not be able to afford.

Alternatives

We still expect employers (where they can) to be issuing EMI options to staff rather than adopting employee shareholder status. With no upfront PAYE/NIC charge and employees still being eligible for entrepreneurs relief even if the option award is for less than 5%. Growth/hurdle shares (whereby restricted shares are valued at nominal value on date of issue due to restrictions and hurdles attached to the shares) remain attractive where EMI options are not available.

If you have any queries on any of the issues raised in this update, please contact Sarah Walton at sarah.walton@weightmans.com or Roland Hutchins at roland.hutchins@weightmans.com.

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