ESS IN A NUTSHELL
The idea behind employee shareholder status is to create a new class of employee (an 'Employee shareholder').
To become an Employee shareholder an individual gives up some statutory employment rights in exchange for shares. There must be no other consideration for the shares. The incentive for the employee to agree to give up his employment rights is that the shares attract very favourable tax treatment.
Broadly, the first £2,000 of free shares received is free of income tax and NIC and the first £50,000 of shares received are free of capital gains tax when sold. Employees must receive at least £2,000 of free shares. This makes ESS shares the most tax efficient shares available to an employee. This arrangement is intended both to create a flexible workforce and incentivised employees.
In contrast to other tax-advantaged share plans, the shares awarded under ESS can be of any class and in almost any type of company; parent or employing subsidiary, quoted or private, trading or investment. This makes it much more flexible than other tax- efficient arrangements.
ESS tax relief is not available to employees who have, or have had in the previous year a material interest in the employer or its parent, being, broadly, 25% of the shares of the company in question.
EMPLOYMENT RIGHTS
Any employee or prospective employee can be offered ESS. The individual enters into an employee shareholder agreement. He must receive independent legal advice paid for by the employer. The employee will not pay income tax on the benefit. There must be a cooling off period of 7 days between the taking of the advice and becoming an Employee shareholder.
The rights that the employee forgoes are principally the statutory right not to be unfairly dismissed and statutory redundancy rights. Other rights, such as anti-discrimination rights, maternity and paternity rights, sick pay, minimum wage, paid leave and so on are preserved.
HMRC has confirmed that ESS is not lost, if, subsequently, employment rights are restored by the employer through the employment contract.
TAX TREATMENT
1) Income Tax
Award of Shares
In order to qualify for relief employees must be allotted fully paid shares of at least an actual market value of £2,000 for no consideration other than entering into an employee shareholder agreement. Where the shares are subject to restrictions that reduce the value of the shares, these restrictions must be taken into account when computing the £2,000 even if the employer and employee enter into an agreement to treat them as unrestricted for employment income tax purposes (a so-called s.431 election) to take the shares outside the restricted securities rules.
The first £2,000 of shares allotted are free of income tax. Any additional shares allotted are subject to income tax and NIC in the normal way.
If the shares are received through an option the same rules apply. In practice, the use of options will only be tax-efficient if the options are tax–advantaged Enterprise Management Incentives (EMI) options.
OTHER CHARGES
Once received other employment related securities rules will apply to the shares in the usual way.
2) Capital gains tax
Any capital gain on the disposal of the first £50,000 of shares received under an employee shareholder agreement is CGT-free. Identification rules apply where relevant. Capital losses are not available on the shares.
3) Employer's tax
Corporation Tax
The usual rules apply to an award of shares for corporation tax purposes. The £2,000 treated as having been paid for other tax purposes is ignored for corporation tax, so a deduction for the award of free shares should still be potentially available.
Employer's NIC is not payable on the award of the shares up to the £2,000 limit.
4) Growth shares and planning opportunities
ESS is very flexible. It is possible to award growth shares that increase substantially in value by reference to performance hurdles for the company.
These shares have a comparatively low initial value in situations where the relevant company performance meets these hurdles: the more stretching the target, the lower the initial value. This can mean that the employee can enjoy very substantial share value growth tax efficiently under ESS.
An individual does not lose the tax breaks if he leaves the company.
5) Valuation of Shares
On a practical level, because of the need to ensure that the £2,000 and £50,000 limits are met, HMRC offers a valuation service similar to that which it offers under EMI schemes. This can greatly facilitate the use of these arrangements.
We have taken care to ensure the accuracy of this publication, which is based on material in the public domain at the time of issue. However, the publication is written in general terms for information purposes only and in no way constitutes specific advice. You are strongly recommended to seek specific advice before taking any action in relation to the matters referred to in this publication. No responsibility can be taken for any errors contained in the publication or for any loss arising from action taken or refrained from on the basis of this publication or its contents. © Smith & Williamson Holdings Limited 2015
