Employee Shareholder Status – new cap for gains exemption

Wed 16 Mar 2016

Employee Shareholder Status was introduced with effect from 1 September 2013 and afforded an opportunity for complete tax exemption on gains realised when shares were sold. That exemption has now been drastically limited, with a new lifetime cap of £100,000 introduced.

Those who have already entered into Employee Shareholder Status (‘ESS’) agreements (prior to midnight on 16 March 2016) might now congratulate themselves on being brave early adopters and they will be pleased to note that there is nothing in the HM Treasury budget press releases to indicate any adverse impact on the tax treatment of such existing awards. This means that any gains on the sale of such ESS shares should remain completely tax exempt, on an uncapped basis. Furthermore such gains will not count towards the new ESS lifetime limit.

However, for those who are contemplating such awards, or are part-way through the offer process, the outlook is now much less attractive than before.

For ESS agreements entered into from midnight on 16 March 2016 a new lifetime limit of £100,000 is introduced to cap the amount of ESS gains exemption. Any ESS gains realised in excess of this limit will be subject to CGT at applicable rates. The only good news on that front is that CGT rates are reducing. Whilst higher rate taxpayers currently pay CGT at 28% this will reduce to 20% with effect from 6 April 2016. The CGT rate for basic rate taxpayers is also reducing, from 18% currently to 10% for 2016/17.

Any transfers of ESS shares between spouses or civil partners is also caught by new tax rules (where the original ESS agreement is entered into on or after midnight on 16 March 2016). Such transfers will be treated as being made for consideration which gives rise to a gain equal to the transferor’s unused lifetime limit, subject to the over-riding condition that the consideration does not exceed the market value of the shares transferred. This amount will fix the acquisition cost in the hands of the recipient.

ESS has found great favour with private equity backed businesses and other employer companies who, for whatever reason, have not been eligible, or preferred not, to make use of other standard tax-advantaged share plans. The arrangement has come in for much criticism since its inception and was dubbed “shares for rights”, due to the need for participants to sacrifice certain employment rights in exchange for the ESS share award. The stated policy intention behind the introduction of ESS in 2013 was to reduce regulatory burdens on business, promote business and employment growth and increase the choices available to business and employees. However it seems that uptake within the financial services sector and amongst other wealthy senior executives has caused HM Treasury to review the quantum of loss to the Exchequer. We might speculate perhaps that the creative use of ESS as a wrapper for awards of growth shares has been the trigger for the review. Certainly it appears as though this new measure is being introduced to prevent perceived abuse, by ensuring that the level of exempt capital gains from disposal of ESS shares is not excessive.

One might argue that the lifetime limit is set far too low and that George Osborne has shot down his own initiative at a time when entrepreneurial business most needs attractive incentives for key talent, to support business growth and productivity. In order to provide motivating post-tax gains to management a compensating adjustment might be to consider awarding more shares to management teams. That however will most likely prove a sticking point with investors, who will have concerns about dilution.

For those who now find themselves pondering the on-going merits of ESS, advice should be sought. ESS remains, in the grand scheme of things, a very tax efficient equity incentive, much more so than a non-tax-advantaged share option award where the full gain at exercise would typically be charged to income tax (@ up to 45%) and NIC (employer @13.8% and employee @2%); it just isn’t quite as attractive as before.

Other ongoing benefits of ESS are:

• £2,000 worth of shares can be acquired free from income tax and NIC;
• £100k gain is exempt from CGT;
• Ability to agree share valuation in accordance with HMRC; and
• Ease of managing claw-back of shares from leavers, with a relaxed process for company repurchase of ESS shares, providing CGT treatment and tax exemption if within the new lifetime limit.

For  further information please contact one of our share schemes experts:

Liz Hunter – Director, Share Schemes and Employer Solutions – (London and National)
T: 020 70634489   E: liz.hunter@mazars.co.uk

Ritchie Tout – Director, Share Schemes and Employer Solutions (Midlands)
T: 0121 232 9627  E: Ritchie.tout@mazars.co.uk