Mark McLaughlin looks at ‘employee shareholder status’ and some of its potential tax advantages.
Many owner-managed companies have ‘key’ employees. The company owners may wish those employees to become shareholders. However, unless the employees pay full market value for the shares, there will normally be income tax (and possibly National Insurance contributions) implications to consider.
This problem is alleviated to some extent by the availability of certain ‘approved’ employee share incentive arrangements, such as the enterprise management incentives (EMI) scheme (ITEPA 2003, Pt 7, Ch 9; Sch 5). However, there is another form of ‘tax approved’ share ownership which, unlike share option arrangements such as the EMI scheme, gives rise to immediate share ownership.
Shares for rights
‘Employee shareholder status’ (ESS) broadly involves the employee agreeing with the company in writing to forego certain employment rights in return for shares with a market value of at least £2,000. No payment must be made for the shares.
The employment rights given up include the right not to be unfairly dismissed (except where the dismissal is automatically unfair or for a discriminatory reason) and the right to statutory redundancy pay (see Employment Rights Act (ERA) 1996, s 205A for the affected rights).
Tax and ESS
Tax incentives were introduced to encourage take-up of this status. The tax features of ESS shares broadly include:
- acquisition of the shares - employees who acquire ESS shares are generally treated as having paid £2,000 for them (ITEPA 2003, ss 226A–226D). Thus the first £2,000 of the market value of the shares is not taxable, and is also free of National Insurance contributions (SI 2001/1004, reg 22(11));
- disposal of the shares – a capital gains tax (CGT) exemption is available to the individual on a gain from the first disposal of ESS shares (TCGA 1992, ss 236B–236G). The CGT exemption applies to qualifying shares issued or allotted to an employee under an employee shareholder agreement with a total unrestricted market value not exceeding £50,000 on receipt (see examples in HMRC’s Capital Gains manual at CG56725). No income tax charge arises if exempt employer shareholder shares are sold back to the company (i.e. on a payment by the company for a purchase of its own shares from the individual), if that individual is not an employee (or office holder) of the employer company (or associated company) at the time of disposal (ITTOIA 2005, s 385A); and
- for the company – cforporation tax relief is available to eligible businesses upon the acquisition of shares by employee shareholders. The employee’s deemed payment of £2,000 for income tax purposes is disregarded for the purposes of the relief provisions (CTA 2009, Pt 12 ‘Other relief for employee share acquisitions’) where an employee shareholder acquires ESS shares (CTA 2009, s 1038B).
However, the income tax treatment on acquisition of the shares and the CGT exemption on disposal are subject to qualifying conditions. These include that the employee (and any connected individual) must not have a ‘material interest’ (as defined) in the company (or relevant ‘parent undertaking’) when the shares were issued or allotted, or within one year previously (ITEPA 2003, s 226D; TCGA 1992, s 236D).
Businesses awarding ESS shares may submit share valuations to HMRC in advance of the award, and HMRC will agree valuations for tax purposes where possible. Any such agreement will be effective for 60 days (www.gov.uk/government/publications/guidance-on-the-income-tax-treatment-of-employee-shareholder-shares).
Practical Tip:
General guidance for those considering ESS is available on the Gov.uk website (www.gov.uk/guidance/employee-shareholders). However, before agreeing to ESS status, the employee must obtain advice from a relevant independent adviser about the terms and effect of the agreement (and there is a seven day ‘cooling-off’ period between obtaining that advice and the agreement being made). The reasonable costs of relevant advice must be met by the company (ERA 2005, s 205A(6)-(7)), and will not normally be a taxable benefit-in-kind (see ITEPA 2003, s 326B), or earnings for NIC purposes (SI 2001/1004, Sch 3, Pt 10, para 24).
ESS will not be suitable in all cases. However, it is a potentially useful alternative to other share incentive arrangements available. The ‘pros’ and ‘cons’ of ESS and share incentives should be compared in each specific case.
