Employee shares – tread carefully

Involving staff in ownership of retail and other businesses could be beneficial. But it could also lead to confusion over the status of different types of employee and complicate tax and national insurance issues.

by Jane Green

EMPLOYEE ownership is far from an alien concept in the retail sector, with the John Lewis Partnership one of the great success stories.

In a bid to broaden its appeal, new rules on employee share ownership are set to come into effect this month (April). However, early indications are that only a very small number of organisations are likely to take advantage of allowing staff to earn a stake in the business.

Jane Green is a partner and head of the Employment & Pensions team at Maclay Murray & Spens LLP and a member of the firm’s Food and Drink team.

On the face of it, the benefits are clear. Research suggests that employee-owned companies have a stronger long-term focus and can enjoy improved performance, as employee loyalty is better fostered, long-term performance is better rewarded and employees are given more of a voice.
At the heart of the scheme is the requirement that, in return for shares, employee shareholders will give up rights in relation to unfair dismissal, redundancy payments and flexible working requests. They will also be required to provide 16 weeks notice of a firm date of return from maternity or adoption leave, instead of the usual eight weeks.
But when determining whether the model proposed by the Government is a good one for existing or new staff, there are a number of potential issues employers need to address.
The new rules could see an increase in discrimination and ‘automatically unfair’ dismissal claims, as these cannot be traded away by employee shareholders. Employers already grappling with the current employment status of ‘employee’ and ‘worker’ and their respective employment rights will also now have to consider that of ‘employee shareholder’.
When announcing the proposals, George Osborne stated that the scheme would be “a voluntary three-way deal”. However, on closer inspection, this does not appear to be the case. Existing employees can be given a choice by their employer, to enter into this new type of contract or not. Conversely, employers may choose to offer only the employee shareholder contract to new hires. As a result, new hires may have no choice but to accept such contracts and waive some of their employment rights, or else miss out on the job. It is, therefore, important to understand the wider implications for workplace relations, as such schemes could create a two-tier workforce. In the longer term, this could affect morale and cut across the apparent benefits of employee-ownership models.
For some food and drinks companies the proposals could also have an impact beyond employment. For example, there could be legal issues arising from having a number of minority shareholders with fear arising over the dilution of ownership and the potential loss of control over key strategic decisions.
A further issue relates to the tax implications. An employee may be given between £2,000 and £50,000 of shares and, when sold, any gain will be exempt from capital gains tax (CGT). It will also be possible for an individual to be granted a stake in excess of £50,000, but the amount above that figure will not be exempt from CGT under this arrangement.
If an employee receives shares from an employer for no consideration, the employee will generally be liable to pay income tax, based on the market value of the shares in the year they are received and the same will be true for employee shareholders. This is a major reason why share options are a more popular alternative to the outright transfer of shares to employees. Additionally, national insurance contributions may also be due, by both the employer and individual, depending on the circumstances of the share acquisition.
In view of the current annual CGT exemption of £10,600 available to individuals, it is highly questionable just how much an employee would gain in tax advantage from the proposed new status. This is particularly the case when balancing the potential value of the employment rights that have to be sacrificed.
Businesses should be able to engage employee shareholders from April 2013. But there is a real risk that implementing employee shareholder status will generate fear and insecurity when certainty and confidence are required. While there is a raft of evidence to support the use of such ownership models and the potential benefits, that must always be balanced against the practicality of implementation and the suitability of the model for any particular organisation.
• Jane Green is a partner and head of the Employment & Pensions team at Maclay Murray & Spens LLP and a member of the firm’s Food and Drink team.