Chancellor hammers home final coffin nail for Employee Shareholder Status

Wed 23 Nov 2016

It was the Conservative party who introduced Employee Shareholder Status (ESS) in September 2013 but it seems the Government have been taken by surprise at its use (not in line with the Government’s intentions) and, after significantly limiting the tax relief in the March budget, today the Chancellor hammered down the final coffin nail and further withdrew the tax advantages.

What is ESS and why is its use now being curbed?
The original ESS legislation created not just a new tax-advantaged equity incentive but also a new employment status. The ESS arrangement provided employees with the opportunity to receive awards of at least £2,000 worth of shares in their employer company or parent company. These awards operated on a ‘shares for rights’ basis, made in return for the employee giving up certain employment rights, although an enhanced contract might also be offered whereby some rights were subsequently reinstated.

The tax advantages conferred on ESS shares are that no income tax or national insurance contributions (NIC) are payable for the first £2,000 (per person) of awards. Any individual share awards above £2,000 are subject to an income tax charge and (potentially) NIC. For awards prior to midnight on 16 March 2016, on a sale of the shares, there was full capital gains tax exemption for the first £50,000 worth of shares (calculated by reference to the unrestricted market value of the shares at acquisition).

For ESS agreements entered into from midnight on 16 March 2016, a new lifetime limit of £100,000 was introduced to cap the amount of the Capital Gains Tax (CGT) exemption. Any ESS gains realised in excess of this limit will be subject to CGT at applicable rates (for 2016/17 that means 20% for higher rate taxpayers and 10% for basic rate taxpayers).

The benefits of ESS are currently:
•   no minimum holding period or minimum size of shareholding;
•   no requirement to remain in employment;
•   no need for the company to be a trading company;
•   can be offered in a controlled subsidiary (i.e. no independence test to be met as  required for other statutory tax-advantaged plans);
•   qualifying shares can even be bought back by the issuing company and cancelled tax-free after cessation of employment (the normal distribution rules on share buy-backs do not apply to employee shareholder shares sold in these circumstances and there are simplified company law requirements too, making leaver claw-backs easier to manage);
•   £2,000 worth of shares can be acquired free from income tax and NIC;
•   £100k gain is exempt from CGT (and uncapped for ESS pre- 16 March 2016);
•   ability to agree share valuation in advance with HMRC; and
•   the employing company will qualify for a statutory corporation tax deduction equal to any amount assessed to income tax in the hands of participants and for the minimum £2,000 value if the shares are in an ‘independent’ company or certain other conditions are met.

The arrangement was always aimed at high growth companies but was particularly attractive for early stage private equity backed businesses and other companies (often in the financial services sector) who were not eligible for other tax-advantaged statutory share plans.

What the announcement means in practice:

•  For existing ESS awards where agreements are already signed:
It seems from HM Treasury press releases that the benefits (stated above) will remain undisturbed.

•  For ESS awards currently in progress where agreements are already with participants for consideration and employees have already received the mandatory independent legal advice before 23 November 2016 (i.e. on or before 22 November 2016):
There is opportunity to receive the desired tax advantages and benefits provided the employee enters into the ESS agreement before 1 December 2016.

•  For ESS awards currently in progress where agreements are already with participants for consideration and employees have received the mandatory independent legal advice on 23 November 2016 before 1.30pm:
There is opportunity to receive the desired tax advantages and benefits provided the employee enters into the ESS agreement before 2 December 2016.

•  For ESS awards currently in progress where employees have not received the mandatory independent legal advice before 1.30pm on 23 November 2016:
There is now no opportunity for the employees to receive the tax advantages currently available, although they remain free to enter into the agreement.

The measures taking effect now do not affect the availability of the status itself (which as noted above also has employment law implications); it simply removes the tax benefits. The Government has however also stated its intention to close the status to new users at the earliest opportunity and as such further legislative changes will be tabled for parliamentary approval to amend the Employment Rights Act 1996 provisions soon.

The new draft legislative clauses do not affect the reliefs available to the company (i.e. the corporation tax relief referred to above) which will remain.

It is worth highlighting that it is not just the income tax position on acquisition of the shares and the CGT position on disposal of the shares that has been altered. The draft legislative clauses, published today in the Finance Bill 2017 ESS explanatory note, amend the position for company repurchases of own shares from Employee Shareholders. The favourable current position is as stated above but in future the payment given by the company may be taxed as a distribution (and not an automatic capital disposal.) This change should only apply to shares acquired in connection with ESS agreements made on or after 1 December 2016 (or 2 December 2016 if applicable per the above).

Our Perspective:
It now appears the Government is aghast that ESS ‘is primarily being used for tax planning purposes by high-earning individuals’ and is potentially de-friending the private equity community by abolishing the planning most favoured for management equity incentives in venture capital backed companies. It seems a strange move at a time when we are seeking to attract and retain highly skilled, scarce, talent to provide the productivity and economic growth so coveted by the Government.

When the Chancellor has acknowledged that businesses like certainty it is also disappointing to now lose another advance assurance share valuation position. One welcome feature of ESS was the ability to agree share values with HMRC in advance – especially useful for shares with particular rights which can be so difficult to value. Often, the share valuation relies on valuer’s judgement regarding the likely future performance of the business so getting early corroboration of this provided some comfort.

The withdrawal of the HMRC post transaction valuation check facility in March 2016 caused some concerns and there have been some suggestions that ESS was being used as a Trojan horse to get HMRC to agree some of the more sensitive share valuations.

The focus now will move back to the genuine commercial purpose of these arrangements: incentivising key staff to grow the businesses for which they work.

In the context of the Chancellor wanting to reduce the productivity gap, well thought-out employee incentives are an essential tool. Numerous independent studies have reported empirical evidence that employee equity incentives are proven to support productivity. ESS was a nice tax wrapper but its loss in no way invalidates the underlying arrangements.

Designing effective incentives which genuinely motivate staff will continue, but unless and until the Government heeds the calls of lobbyists to relax the independence test requirements for other traditional statutory tax-advantaged plans, the alternative solutions will now need to be more bespoke.

For further information please contact our share schemes team:

Liz Hunter
Head of Share Schemes
T: +44 (0)20 7063 4489
E: liz.hunter@mazars.co.uk

Ritchie Tout
Tax Director, Share Schemes
T: +44 (0)121 232 9627
E: ritchie.tout@mazars.co.uk

Liam Liddy
Senior Manager, Share Schemes
T: +44 (0)20 7063 4198
E: liam.liddy@mazars.co.uk