Employee shareholder contracts – HRLaw’s need to know guide

From September 2013, employers will be permitted to give a new employee shares in the employer’s business in return for the new employee giving up some fundamental employment rights.  Shares awarded under the new arrangements enjoy generous tax reliefs.  Crucially, however, the rights given up do not extend to all employment rights, and if employers do not follow the strict implementation rules then employees may gain shares without waiving any rights at all.

Below we answer your FAQs on how the new rules will impact on employers.

What rights can be given up?
Employees will be required to forfeit their statutory rights in relation to:

• unfair dismissal (except in special cases),
• redundancy,
• the right to make a flexible working request, and
• the right to make a request in relation to study or training.

Employees who are engaged under such contracts are also required to provide their employer with extended notice (16, rather than 8, weeks) of when they intend to return from maternity, additional maternity (or adoption) leave.

Most importantly, employees will not be required to forfeit their right not to be unlawfully discriminated against or to make whistleblowing claims.

What shares do I need to give in return?
There are strict rules as to what (and when) the employee must receive shares. As a summary:

• the employee must be given fully paid up shares (in either the employing company or its parent);
• the shares do not have to be listed on a stock exchange (though valuation of unlisted shares could present some problems and will certainly require an independent valuation);
• the shares must have a minimum value of £2,000 but there is no maximum value (the valuation must take into account any restrictions on the shares, such as the obligation to transfer or forfeit them on ceasing to be an employee; such restrictions could significantly reduce the value of the shares for this purpose).

If the shares do not fulfill the strict conditions of the legislation, the new employee will not be an “employee shareholder” and will not deemed to have given up their employment rights.

What is the tax treatment?
From a tax perspective:

• the first £2,000 worth of shares may be given to the employee free from income tax and national insurance contributions (but any value over £2,000 will be subject to income tax and NICs); and
• any gain the employee makes when they later dispose of the shares is exempt from capital gains tax (to the extent that the shares were worth no more than £50,000 when they were acquired).

Are there any legal/administrative issues?
Yes, in order to protect employees:

• you must explain the rights the employee is giving up,
• you must provide details of the shares being offered and the rights and restrictions attaching to them,
• a new hire or existing employee must be given a 7 day cooling off period, and
• a new hire or existing employee must receive independent legal advice before they accept the offer and you must offer a reasonable contribution towards their legal fees.

Can I require existing employees to become “employee shareholders”?
No. You can require new employees to adopt “employee shareholder” status. However, you can only offer existing employees the option to switch to employee shareholder contracts but you cannot force them to do so.

Do I have to buy back shares from departing employee shareholders?
Whilst there is no obligation on an employer to buy back shares from an employee shareholder who ceases employment, employers (other than listed companies) will typically want to require the employee to sell back their shares.

This causes its own difficulties. For example, how much will the shares be bought back for? If the shares are to be bought back for less than market value at the time employment ceases (when the shares may be worth significantly more)  this could affect the value of the shares when they are awarded, reducing their value below £2,000, in which case the employee will not properly have given up their employment rights. If the shares are to be bought back for market value, where will the resources be found to buy back the shares?

Do you think it is a good idea?
In practice, this will depend on the size/type of company you are (in particular, whether your company’s shares are listed or your company already has established share schemes in place) and the type of employees to whom the new employee shareholder contracts are offered (for example, senior management versus ordinary employees who are not involved in management).

Though the arrangements were intended to benefit small companies, as a result of the various conditions the arrangements are more likely to be attractive where your company’s shares are listed or your company already has established share schemes (and therefore a mechanism for valuing shares) in place.  Given the tax advantages, the proposals may also be an appropriate part of a package to new management/senior management, where the employment rights given up may be less relevant.

If you would like to find out more, or for assistance in drafting offers to prospective employee shareholders, please contact your usual Fox Williams contact.