The scheme comes with tax advantages: income tax relief when acquiring shares up to the value of £2,000 and a capital gains tax exemption on any profit made when shares acquired at a value of £2,000 to £50,000 are sold.
Attractive as this may sound, there is a price to be paid. Employee shareholders are not entitled to claim unfair dismissal, or to receive redundancy pay. They are also denied certain statutory rights to request flexible working and time off for training. Although they will still be protected from “automatic” unfair dismissals, such as discriminatory dismissals or those which occur as a result of whistle-blowing, this represents a significant reduction in basic employment rights.
The proposal was rejected by the House of Lords twice when the bill was passing through Parliament. Third time lucky, the legislation makes clear six conditions must be met before an individual can become an employee shareholder. The scheme is optional so there has to be mutual agreement between the employer and employee. The employee must receive fully paid-up shares in the company worth a minimum of £2,000 for free. The employer has to issue a statement of particulars of employment. The employee shareholder then has to get independent advice on the terms and effect of that statement (paid for by the employer). Finally, the employee must be afforded a seven-day cooling off period in case they change their mind.
The original government proposal was aimed at encouraging employee participation in business, yet there is no restriction on the types of shares which employers issue. There is no requirement that the shares have any voting or dividend rights. In addition, when the employee shareholders leave the company, employers will be able to require them to forfeit their shares. It was originally anticipated that they would receive at least “reasonable value” for the shares. Instead, the legislation simply provides that forfeiture of shares is a matter for agreement between the employer and employee.
It is difficult to identify just who will be interested in giving up their rights for shares. Perhaps just a lucky few who feel they don’t need employment protection and who wish to avail of the tax efficient scheme. Even then, charging income tax on shares over £2,000 up front will probably act as a disincentive for many. It is also doubtful that a capital gains tax exemption will incentivise individuals to give up their rights, particularly if the shareholding is small and the gains are within the annual exemption.
Another more obvious point is that the share value might fall, leaving the employee with much less than they bargained for and the employer with a disillusioned workforce.
From the employer’s perspective, who would want to give up shares for rights? It is not as simple as allocating shares to reduce exposure to employment claims. Employers will still need to follow proper procedure when dismissing employee shareholders to avoid claims that the dismissal was discriminatory. Meanwhile, in a redundancy situation the cost of redundancy pay may be replaced with the cost of valuing shares. Finally, whilst they might get more notice when an employee shareholder returns from maternity leave, they won’t be able to ignore flexible working requests from employee shareholders as that will again fall foul of discrimination law.
In addition, the move might backfire. Take, for example, a start-up or growth company using employee shareholder status to encourage skilled workers to enter their business. It will be a blow if the skilled individuals leave to capitalise on the rising share price.
The scheme is not expected to be popular. It has been criticised as a tax avoidance scheme. Indeed, reports suggest that since its inception employers in the private equity industry have offered shares to senior managers to cut their tax bills. We will wait to see whether others seek to use the scheme to their advantage, but for the time being, don’t expect any clamour for shares from the workforce.
• Robert Holland is a partner and head of employment with Balfour+Manson LLP www.balfour-manson.co.uk