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This article first appeared in the Tax Journal on the 13 June 2014
Conventional approaches to the use of employee share plans need revisiting. In addition to understanding how to get shares tax efficiently into the ownership of individual employees, it is now important to understand the wider concept of employee ownership (EO), and especially the idea that a company may be owned by the trustee of an employee trust on behalf of all its employees. This year’s Finance Act (subject to enactment) will confirm important new tax exemptions to support this trust model of ownership and, in particular, to encourage its use as a business succession solution.
The meaning of EO
Employee share plans are predominantly used as a way to remunerate staff. Tax advantaged share plans work well to achieve this aim by providing tax e!ective ways for individual employees to acquire and dispose of shares.
But instead of allocating an insignicant percentage of shares among employees, why not allocate a signicant stake in the company to staff? Instead of just using the economic rights on shares to benefit staff, why not harness voting rights to engage staff fully in how a business is owned and governed? This is what happens with EO. EO means a signicant and meaningful stake in a business for (ideally) all its employees. What is meaningful and signicant goes beyond financial participation. The employees’ stake must underpin organisational structures that promote employee engagement in the company. In this way, EO can be seen as a business model in its own right.
Many of the leading UK companies with EO are 100% employee owned. But lesser percentages can also deliver the benets of EO. The government’s Mutual Support Programme for public service mutuals sets a minimum 25% EO threshold. As minister for the Cabinet Office, Francis Maude explained this is ‘so that staff can exercise at least negative control over the entity’ (Robert Oakeshott memorial lecture on employee ownership and the future of public services, 25 March 2014). The government introduced ‘employee shareholder’ status from 1 September 2013 (FA"2013 s 55 and Sch 23). This should be seen as a niche measure, which is very separate both in terms of content and scale from EO.
The Nuttall review
Important reports from the Oce of Tax Simplication on tax advantaged employee share schemes and unapproved share schemes (available via www.bit.ly/1wSyepr) have encouraged the government to refresh the tax rules for direct employee share ownership (see FA 2013 s 14, Sch"2 and Finance (No. 2) Bill (2013/14) cll 46–49, Schs"6"& 7).
Separately, deputy prime minister Nick Clegg announced on 16 January 2012 ‘a drive … to get employee ownership into the bloodstream of the British economy’. This led to the publication of Sharing success: The Nuttall review of employee ownership (‘the Nuttall review’) by the Department for Business, Innovation and Skill (BIS) on 4 July 2012 and a series of measures summarised in e Nuttall review of employee ownership: One year on report, published by BIS on 19 November 2013.
Research and success stories
The Nuttall review summarised research on EO and associated concepts. ere is a powerful message from this research, namely that EO provides better business performance alongside benets for staff.
What usually works best at generating interest in EO are the success stories, though, the examples set by companies such as such as Arup, the John Lewis Partnership, Scott Bader Commonwealth and Wilkin & Sons (Tiptree Jams). There are more examples on the websites of the Employee Ownership Association and the Cabinet Office Mutual Information Service. These examples show how EO may be used in startups, in business rescues, to help achieve growth in an established company and as a succession solution.
One of the key findings of the Nuttall review was the need to raise awareness of EO. Measures to achieve this include EO Day. EO Day was held for the first time on 4 July 2013 and is a day dedicated to highlighting and celebrating the benefits EO delivers to the UK economy.
Official guidance
Another key finding of the Nuttall review was the need to increase the resources available to support those who wish to introduce EO. There are now guidance materials produced or endorsed by the government on EO. there is, for example, for the first time a guide for employees who wish to initiate discussions about a move to EO, published jointly by BIS and the Advisory, Conciliation and Arbitration Service (ACAS). There are dedicated web pages on the hmrc.gov.uk, gov.uk and acas.org.uk websites which link to this and other guidance on EO (for example, see www.bit.ly/1hr6Wm1). The various consultation documents and minutes of the Nuttall Review Implementation Group also provide additional background information.
Toolkits
There is a great deal of knowledge about how to get shares into the hands of employees. The precedent documents and necessary legal and tax knowhow are readily available and can be adapted to implement direct EO. The government has now taken steps to fill a know-how gap in relation to indirect EO by publishing a tool kit for employee trust ownership on its website (see http://www.bit.ly/1wSzPLZ). This deals with setting up an employee trust and trustee company. HMRC has published accompanying guidance on tax issues (http://www.bit.ly/1hr74Ss).
Companies Act 2006 changes
A further obstacle to promoting EO was the apparent complexity of it and so the Nuttall review recommended various regulatory changes. As a result, changes to the Companies Act 2006 help the direct EO model, by making it easier for every company to buy in shares from employees who leave and cancel them, or hold them in treasury (The Companies Act 2006 (Amendment of Part 18) Regulations, SI 2013/999). This means that instead of establishing an employee trust as a market maker, which adds to the complication and cost of operating an employee share plan, it may be that a private company can operate its direct share ownership model better by the purchase of its own shares using these relaxations in company law. There is accompanying guidance from BIS (available via www.bit.ly/1oZTBAP) and HMRC (http://www.bit.ly/1l0aryE). The HMRC guidance confirms, for example, that the changes to the purchase of own shares provisions do not themselves make shares into readily convertible assets. It is important to realise that there have been no accompanying changes in tax law. It may remain best from a tax point of view for an employee to sell shares to the trustee of an employee trust. In response to concerns about how some of the new rules work, the government is considering additional legislative changes to improve the operation of the provisions.
Raising awareness through tax changes
A new CGT exemption and income tax exemption could be key in maintaining the growth of EO in the UK. Both these exemptions help simplify indirect EO and, in particular, the CGT exemption encourages its use as a succession solution. There is a CGT exemption when a controlling interest in a company is, in broad terms, transferred (other than by a company) to an employee ownership trust (EOT). The CGT exemption applies from 6 April 2014 (subject to enactment of Finance (No. 2) Bill 2013/14 Sch 33 Pt 1, as published on 27 March 2014) and is unlimited in amount. Instead of a trade sale or other conventional form of exit, owners may now opt for an EOT buy-out as their succession solution. There will also be, from 1 October 2014 (subject to enactment of Finance (No. 2) Bill 2013/14 Sch 33 Pt 2, as published on 27 March 2014), an exemption from income tax (but not NIC) of £3,600 per employee per tax year for certain bonus payments made to employees of a company (or group) where an EOT has a controlling interest. This provides an alternative to operating a share incentive plan.
The EOT
Key to these tax exemptions is the EOT. This is a more restrictive form of an employee trust than an IHTA 1984 s 86 trust. But the initial indications are that the differences are acceptable in the context of a trust that is designed to acquire and hold shares indenitely on behalf of employees.
One additional restriction is that the EOT must not include a power for the trustee to make loans to beneciaries. A key difference relates to who must benefit from any distribution from the EOT. A s 86 trust usually defines its beneciaries by reference to employment with a particular body, but can limit the class of beneciaries to ‘all or most’ of the persons employed by the body concerned. In contrast, an EOT must not permit ‘any of the settled property to be applied, at any time, otherwise than for the benefit of all the eligible employees on the same terms’ (TCGA"1992 s 236J). Essentially, every employee of the relevant company or group must be an eligible employee, except for certain excluded participators. The same terms requirement does permit differing amounts to be paid to eligible employees but every such employee must receive something.
Perpetual employee trusts?
The Nuttall review recommended that employee trusts should be able to last forever. The government is considering a change in law to implement this recommendation (see www.bit.ly/1l0aFFS). If this happens, it is worthwhile providing in new employee trust deeds for the usual perpetuity provisions to cease to apply if the trust ever becomes exempt from the 125 year perpetuity period imposed by the Perpetuities and Accumulations Act 2009.
Action point for advisers Remember the potential of EO. Advisers need to remember there is more to share plans than incentivising a few executives or providing tax ecient rewards to sta!. EO is a distinct business model and EO can provide solutions at every stage of the business life cycle and across all sectors and sizes of business. But the new EOT tax exemptions give particular prominence to the indirect EO business model and its potential as a succession solution. So when a client next says: ‘I am thinking of selling my company…’, remember to reply: ‘Have you thought about EO?’
Diverse models of employee ownership
There are different models of EO. Each business can adopt a model that best suits it and its employees. Briefly, the employees’ stake may be held:
- directly, typically using tax advantaged share plans to enable employees to own shares individually (direct EO);
- indirectly, through an employee trust owning shares permanently on behalf of employees (indirect EO); or
- through a combination of direct EO and indirect EO.