The UK Chancellor announced at the Conservative Party conference this week an outline plan to enable a new category of “employee owners” to receive shares in exchange for zero capital gains tax and a significant reduction in employment rights (the press release is here). Whether this will be a sufficiently attractive carrot to justify diversion from the well-trodden path for emerging companies of granting simple and highly flexible Enterprise Management Incentive (“EMI”) options and/or to entice employees away from their statutory employment protections remains to be seen, as does much of the fine detail of the proposal.
The proposal has arisen as part of the Nuttall Review of Employee Ownership and envisages a new type of contract of employment where a new category of employees (“employee owners”) could opt to take up between £2,000 and £50,000 of shares in the employer. In exchange, they would have to give up their statutory rights of unfair dismissal, redundancy payments, the right to request flexible (part-time) working and take time off for training and will be required to provide sixteen weeks’ notice of a firm date of return from maternity leave (instead of the current eight weeks’ notice).
Current employees could be moved onto employee owner contracts, but could not be forced to do so. New hires could be offered employee owner status or conventional contracts at the employer’s discretion. Companies of any size would be able to use this new kind of contract of employment, which differs from EMI schemes (which are restricted to smaller companies with fewer than 250 employees and no more than £30m of balance sheet assets).
Employee owners would pay zero percent capital gains tax on gains on the shares awarded as part of their contract of employment. They would also be eligible for existing employee share ownership schemes such as the EMI. Gains on EMI options are already taxed as capital gains rather than employment income, giving favourable tax results but less favourable than zero percent. The government has notably failed to mention what the income tax treatment of the shares will be, however.
The Government will consult on details of the new employee owner contract later this month, when more detail will be given. Draft legislation is due later this year under the proposal, with the “go-live” date being April 2013. For now the detail of how this will operate is unclear, including what if any forfeiture provisions, vesting and deferral options or requirements might apply. It is also unclear what the valuation base will be for the £2,000 minimum value requirement. For many start-up businesses, the £2,000 minimum value requirement for the shares may restrict the application of the regime, even for individuals who have quite significant stakes in the business. There may also be an issue in that companies want to obtain a low valuation for EMI purposes but will need to show a higher value to encourage more employees into employee owner status. Obtaining a low share valuation at the time options are being granted is a key element of maximizing the benefit of EMI option grants for employees, so this may be a more significant issue in practice than those developing this policy currently understand.
It is also questionable how many employees will wish to take advantage of this potentially risky option in return for giving up their rights on dismissal, especially in these uncertain times. The proposal is likely to be of most interest to start-up and smaller operations (assuming they can overcome the valuation point detailed above) who are already committed to employee ownership and have little money to spare for employment claims and severance packages. Yet these are the very organizations which will present the greatest gamble for employees being recruited from more established organizations. In order to attract the best talent or to convince existing employees to convert, therefore, the employer may in practice have to enhance the benefits or protections on offer and the current proposal specifically envisages and approves the possibility of such an enhancement.
We remain a little sceptical about this proposal at this stage given that key elements of the recent ‘Report on Employment Law’ by venture capitalist Adrian Beecroft, which were announced in a hail of publicity as radical and innovative changes (for example, compensated no fault dismissals) were then quietly dropped after obvious implementation problems were identified during consultation—and the similarly trumpeted “protected conversations” concept turned out to be little different to the current common law position. We will watch with interest for further developments on this revolutionary new proposal as they arise.