As widely reported this week, George Osborne has announced Government plans for new “owner-employee” employment contracts. While these are intended to help start-ups and other small businesses, it is possible that they may also become a feature of private equity financed companies.
The proposal is that under these contracts employers will, in effect, be able to give employees between £2,000 and £50,000 worth of shares in the company in exchange for the employee giving up certain statutory employment rights, including rights to compensation for unfair dismissal and redundancy and the right to request flexible working. Such shares will then be exempt from CGT on eventual disposal.
The announcement was light on detail, particularly on tax issues which should become clearer when a consultation document is published later this month. It is not yet clear whether the award of shares will be subject to income tax and NICs in the same way as a bonus or “golden hello”, or effectively non-taxable on the basis that the employee has given value for them by giving up employment rights.
In practice it is likely that most employers will want to impose a compulsory transfer requirement on termination of employment to avoid a disaffected former employee becoming a hostile minority shareholder. The press release from the Department for Business, Innovation and Skills suggests that this will be possible provided the employer pays a “reasonable price”. It remains to be seen whether employers will be able to distinguish between good and bad leavers, paying good leavers more than bad ones and permitting good leavers to keep some or all of their shares depending on length of service. Unless these shares are tax-free on acquisition, restricted securities elections will presumably be necessary to avoid tax on vesting, the lifting of other restrictions and disposal. Presumably there will be no inhibition on drag and tag and lock in provisions.
It appears that this arrangement will only be available for employers that are companies rather than unincorporated businesses such as sole traders and partnerships. Some of the smallest businesses and start-ups will therefore not be able to take advantage of “owner-employee” contracts to reduce their exposure to industrial tribunals unless they incorporate. This is perhaps surprising in the light of recent criticism in the media of individuals using companies to take advantage of lower corporation tax rates. Structuring an equivalent form of equity participation outside the corporate context would though be more complex.
The main aim is to reduce the financial risk for employers taking on new staff. Employees will be able to require new joiners to have “owner-employee” status. They will not be able to impose this on existing employees. Existing employees cannot be required to change status but can do so by agreement with their employer. Such share awards towards the upper end of the scale might be a more attractive option for those who have faith in the company’s future and are confident that they can perform well enough not to need employment protection. Employers and private equity investors like to see employees with these characteristics and, whilst it will not be permissible to require existing employees to switch status, it is easy to imagine that employees will be encouraged to show their commitment in this way.
See the Alerter from our Employment team for further analysis of employment issues: