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Employee-owner contracts explained – and the questions that need answering

What does the employee-owner contract mean for start-ups and small businesses. haysmacintyre’s Natasha Frangos and Mark Allwood explain

Many would have read of the recent announcement made by the chancellor George Osborne, regarding the plans for a new kind of employment contract, called an employee-owner. With Mr Osborne describing it as a “radical change to employment law”, we look at the proposal in more detail below.

What is an employee-owner contract?

A new form of contract where employee-owners will exchange some of their UK employment rights for rights of ownership in the form of shares in the business they work for.

What does it mean?

Under the contract, employees will be given between £2,000 and £50,000 worth of shares that would be exempt from capital gains tax (CGT) when eventually sold.  In exchange they will give up their UK rights on unfair dismissal, statutory redundancy payments and the right to request flexible working and time off for training. In addition, employee-owners will be required to provide 16 weeks’ notice of a firm date of return from maternity leave, instead of the usual 8 weeks.  Importantly, rights in relation to discrimination would remain and would presumably need to be considered when allocating the shares.   Employee-owners receiving full capital gains tax relief on the shares awarded as part of their contract will still be eligible for existing employee share ownership schemes such as the Enterprise Management Incentive (EMI).

Which businesses can use the new employment contract and which employees would it apply to?

Companies of any size will be able to use this new kind of contract, but it is principally intended for fast -growing small and medium-sized businesses. The employee-owner status will be optional for existing employees but both established and new start-ups can choose to offer only this new type of contract for new hires. Companies recruiting employee-owners will continue to have the option of inserting more generous employment conditions in to the employment contract if they choose to.

Why has the government put forward this proposal?

The proposal hopes to boost employee participation, productivity and commitment in line with the success of a business, at the same time creating greater flexibility in the labour market.

Which businesses are most suited to the new arrangements?

The scheme might be attractive to start-up companies, particularly in new hi-tech industries, which are unable to pay large salaries, but instead can tempt ambitious staff with a share in equity which could potentially realise considerable value.

However, there is cause for concern in the event that it is possible to strictly control voting rights, which could mean that big businesses may also be interested in this approach as a possible way of restricting employment rights for a relatively small financial outlay.

What happens in the event of the employee-owner being dismissed or made redundant?

Legislation to bring in the new employee-owner contract will follow later this year so that companies can use the new type of contract from April 2013. The government is due to consult on the details of the legislation later this month.

The government consultation will include detail of restrictions on forfeiture provisions to ensure that if an employee-owner leaves or is dismissed, the company is not able to simply take the shares back but will have to buy them back at a reasonable price. This buy-back mechanism is one of many hurdles still to be overcome by the government in relation to this scheme.

How many unanswered questions…..?

Well there are quite a few…

  • What will be the status of the shares issued, in particular in terms of voting and dividend rights?
  • Will the shares have to be purchased or given by the employer?
  • What will be the tax implications for the employee-owner and employer on issuing the shares? The announcement proudly states the shares will be capital gain tax free but omits to mention that awarding shares for no consideration creates an immediate employment tax charge. Will the law be changed to monetise employment rights so that, for example, forgoing redundancy payments will be the employee’s “consideration” for the shares they acquire?
  • How does the range of £2,000 to £50,000 worth of shares operate? Will it be linked to the rights surrendered?
  • How much financial information will the employee-owner be entitled to in order to assess the health and prospects of the company?
  • In the event the company buys back the shares on termination of a contract, how will the “reasonable price” be calculated and who will pay for the valuation?
  • Will the legislation contain “good/bad leaver” provisions in the event an employee is dismissed for gross misconduct or will these terms be subject to negotiation?
  • For group companies, will the shares be issued in the employing entity or the parent company?
  • How can small companies communicate to employees in a cost effective way the complex employment and tax law consequences of the scheme? What will the government do to help with this practical barrier?
  • The devil, as they say, will be in the detail. With the Government consulting later on this month, it will be interesting to see the full proposal and only then will it be possible to understand what the full impact could be.

While the scheme is unique in trying to reduce the burden of employment law and encouraging employee participation, one can’t help but feel it is good in theory but will be complex and costly to adopt in practice, leading to little take up by the entrepreneurial businesses it was designed to help.

Natasha Frangos and Mark Allwood are both partners at mid-tier accountancy firm haysmacintyre, which specialises in advising ambitious entrepreneurial companies. Frangos focuses on the creative, media and technology sector, while Allwood manages the business tax department. www.haysmacintyre.com

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