Employee owner contracts - only three weeks to respond to the government’s consultation, launched yesterday Add To My Clippings Alt Text

Consultation and implementation

Following on from the Chancellor’s announcement, on 8 October 2012, of proposals for “employee owner” contracts, a new type of employment relationship whereby employees give up certain employment rights in exchange for shares in their employer, the government has launched a consultation providing further detail on the proposal and seeking views on how best to implement it.

In keeping with the government’s ambitious aim of bringing in the new arrangements by April 2013, the consultation will run for just 3 weeks and will close on 8 November 2012.

Opposition

Unions have fiercely opposed the initial proposal as “slashing” employment rights, and even the CBI has been lukewarm in its support, describing it as a “niche idea and not relevant to all businesses”. Employment lawyers and HR professionals have largely been sceptical; pointing out a number of potential problems with the workability of the proposal.

The consultation therefore has a key role to play in ironing out many of the issues that have been identified and getting the proposal into a workable form. Whilst there is additional information in the consultation, many questions remain.

Proposals

What we do now know is that the government has confirmed that the employment rights which will be given up by employee owners are the rights not to be unfairly dismissed (with limited exceptions), statutory redundancy pay and request flexible working and time off for training. Employee owners will also need to give more notice when returning from maternity or adoption leave. Although these are some key employment rights, many key employment rights are not included in this list (e.g. whistleblowing and discrimination rights). The government is prevented from extending the scope of excluded rights by, amongst other things, EU law.

What sort of shares?

The government has also confirmed that employers will have substantial flexibility in determining what rights the shares will have which can be offered to employee owners, for example, whether shares offered will carry voting rights or the right to receive dividends.

Shares will be valued according to their “unrestricted market value”, which is the price they might reasonably be expected to fetch on the open market disregarding any restrictions. The consultation acknowledges the potential difficulties of valuing shares in companies whose shares are not publicly traded and the government’s response to this problem is to state that the proposal will not impose any valuation requirements beyond those that already exist when valuing companies for other tax purposes.

The shares offered can also be restricted, in other ways – for example, employee owners could be required to surrender their shares if they resign or are dismissed. The government will require that surrendered shares are bought back at a “reasonable value” but there is little guidance on how “reasonable value” will be established. The consultation asks for input on whether forfeited shares should be purchased at “full market value” or a “fraction of market value” and whether this should be varied in certain circumstances. This is an important point to get right because if clear mechanisms for establishing the value of surrendered/forfeited shares are not established it will be a recipe for confusion and, ultimately, expensive and time consuming litigation.

Taxation

The consultation document also makes clear that while shares acquired by employee owners will enjoy exemption from capital gains tax when sold, they will be subject to income tax and national insurance contributions when acquired in the same way as shares currently acquired by employees are. This clearly has the potential to reduce the attractiveness of the scheme for would-be employee owners, and as yet it is unclear whether the value of the employment rights being given up will be taken into account to reduce or eliminate any such tax charges.

Potential consequences

The government has stated in the consultation document that it wishes to ensure there are no “unintended consequences” to its proposal. One potential consequence is that its use by start-up companies in particular may be prejudiced by the requirement for employee owners to be given a minimum of £2,000 worth of share, as that would typically represent a very large percentage of the company’s total initial share capital.

Another potentially significant unintended consequence is that under the existing proposal, it may be possible for entrepreneurs to set themselves up as employee owners in order to avoid capital gains tax. In practice, these entrepreneurs will be far more “owner” than “employee” and the employment rights they will be giving up are likely to be of much less value to them than to ordinary employees and the tax advantages of far greater value to them than to ordinary employees. It is doubtful that the government intends for its proposal to be a way for prospective Mark Zuckerbergs to avoid capital gains tax and it will be interesting to see whether the government’s final proposal will address this. Until then, it remains to be seen whether it will be “owners”, rather than employees, that end up being the big winners under this proposal.

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