The ESS trade-off
With effect from 1 September 2013, the Employee Shareholder Scheme (or ESS) has allowed companies to offer a new form of employment status to new and existing employees in conjunction with a highly tax efficient employee share scheme.
Under the Employee Shareholder Scheme, employees agree to waive/vary certain statutory employment rights in exchange for at least £2,000 worth of newly issued shares which benefit from potentially very significant tax breaks.
The Employee Shareholder Scheme “shares for rights” proposal was hotly debated prior to its introduction, but is now well bedded in and available. ESS is a very useful tool for companies looking to tax efficiently incentivise key employees whilst also allowing them to reduce their potential employment costs.
What are the benefits of the Employee Shareholder Scheme?
The Employee Shareholder Scheme offers significant tax savings to ESS employees and their employer and make ESS the most tax efficient share scheme ever available for employees in the UK.
Due to the rights for shares trade-off mentioned above, the tax benefits are likely to make the Employee Shareholder Scheme attractive to employees who value tax free equity returns above the employment rights that they waive/vary.
The Employee Shareholder Scheme is commercially flexible and can therefore be made to be risk-free for company owners; with dilution and minority shareholder rights being managed appropriately.
Are there any limits?
In order to qualify, the Employee Shareholder Scheme shares must have a value (at acquisition) of at least £2,000. There is however no upper limit on the number/value of shares that can be issued.
It is important to note, however, that the Capital Gains Tax (CGT) exemption (see What is the taxation treatment of ESS shares? below) is available on the first £50,000 worth of ESS shares only (again valued at the time when the shares are issued).
Unlike the popular and tax efficient Enterprise Management Incentive (EMI) scheme, there are no size limits on company eligibility and the Employee Shareholder Scheme can therefore be used for companies with significant assets/employee numbers.
What kind of companies can use the Employee Shareholder Scheme?
Both UK and overseas companies with a share capital can use the Employee Shareholder Scheme. Another advantage over EMI, is that under the Employee Shareholder Scheme there is no qualifying trade criteria to satisfy – thus making ESS potentially of use to non-EMI qualifying companies.
Companies implementing the Employee Shareholder Scheme have significant flexibility in deciding on the relevant rights that apply to the ESS shares – provided that the shares are issued in the employer or the employer’s parent. The company also has the scope to determine the rights of the Employee Shareholder Scheme employees who leave employment with, in most cases, the Articles requiring departing employees to forfeit their shares for an agreed pricing methodology.
What rights does an ESS employee waive/vary?
Employees under the Employee Shareholder Scheme give up statutory rights to:
- redundancy payments;
- unfair dismissal (excluding automatically unfair reasons or unlawful discrimination);
- request flexible working; and
- request time off for training.
In addition, ESS employees are required to give greater notice under maternity/certain other family event provisions.
Interestingly, the Government has suggested that it is possible to reinstate the waived statutory rights; so that employees may be given equivalent contractual benefits but still quality under ESS.
What is the taxation treatment of ESS shares?
Shares issued under the Employee Shareholder Scheme benefit from a number of tax breaks including:
- CGT free growth in value which, unlike CGT Entrepreneurs Relief, is uncapped;
- No income tax/NIC on acquisition of the Employee Shareholder Scheme shares on their first £2,000 of value – this exemption means that bringing the tax value of the ESS shares as close as possible to £2,000 is likely to improve tax efficiency. This is particularly so as ESS shareholders are not allowed to pay anything for their ESS shares (other than being deemed to have paid £2,000 worth of consideration through their foregone/waived employment rights);
- No CGT/income tax on a purchase of own shares by the issuing company in certain circumstances; and
- The cost that the company contributes towards the employees’ independent advice (see What is the process under the Employee Shareholder Scheme? below) will generally not be taxable in the employees’ hands.
There are a number of conditions for the above reliefs to apply, including the valuation of the ESS shares and the ESS shareholder not being seen as having a “material interest”.
What is the process under the Employee Shareholder Scheme?
The Employee Shareholder Scheme is, in essence, another form of employee share scheme with, in most cases, the design followed by drafting of a set plan of rules and amendments to the Company’s Articles.
Once the design of the ESS rights has been finalised, potential Employee Shareholder Scheme participants must then be given:
- A written statement of particulars from the company (detailing the employment right variations and certain prescribed ESS share rights);
- Independent advice on the “terms and effect” of becoming an Employee Shareholder Scheme employee – the reasonable costs of which must be borne by the employer; and
- A 7 day cooling-off period following the receipt of the independent advice must occur before being able to formally become an Employee Shareholder Scheme employee.
Do we need to approach HMRC under the Employee Shareholder Scheme?
ESS, is, in effect, a pre-approved HMRC arrangement so no specific HMRC approvals are required. The company, the shares and ESS employee will however need to meet the relevant ESS qualifying conditions.
It is advisable, however, to use HMRC’s advance valuation facility to obtain agreement to ESS share values. This provides the company and the ESS employee with certainty on valuation and on the tax effect of the arrangements.
How we can help?
We advise on the feasibility of the Employee Shareholder Scheme and help design, draft and implement ESS for our clients. We cover all tax and legal issues and liaise with share valuers to value the relevant ESS shares.
On matters where we are not advising the company, we act as independent advisers for employees who are being offered ESS status, advising them on the terms and effect of the arrangements.