Important note for companies which filed annual share scheme returns

As we have reported previously, HMRC now operates an online registration and notification system for employee share schemes (ERS Online).

All annual returns for tax year ended 5 April 2015 for employee share schemes (whether tax-advantaged or not) had to be filed by 6 July 2015.

Earlier this year, however, HMRC reported technical operating difficulties, and the ERS Online system was taken down shortly before the original scheme returns deadline of 6 July 2015, to allow work to be carried out to correct a fault. HMRC then made the system available again to users from 20 July 2015, and the original deadline was extended to 4 August 2015.

HMRC has now confirmed that these technical faults adversely affected uploaded files relating to a number of scheme returns, submitted via ERS Online before 20 July 2015. We understand that HMRC will be writing to the companies concerned requesting them to resubmit their share scheme returns. We also understand that penalties for late submission will not be imposed in this case (on the basis that the original returns were submitted via ERS Online in good faith!)

We understand that HMRC proposes to issue a letter to the companies concerned shortly. This letter is likely to be addressed to the relevant Company Secretary, so this is something to look out for in case your company (or one of your client companies) is one of those affected.

If you or your clients would like to discuss any of the developments mentioned in this newsletter, please contact:

Robert Postlethwaite

David Reuben

Stephen Chater

Judith Harris

or call us on 020 3818 9420

Valuing restricted shares impact of decision of First-tier Tribunal

The valuation of private company shares acquired by, and disposed of by, employees is a complex field which has frequently caused confusion and misunderstanding.

There are several different share valuation methods which can be adopted for tax purposes. Which one will apply in a particular case will depend on the circumstances of the event giving rise to the tax charge.

Since 2003, the tax treatment for restricted shares has been governed by Chapter 2 of Part 7 of the Income Tax (Earnings and Pensions) Act 2003. This legislation is fairly complex, but to date, few cases on its interpretation have been heard by the tax tribunals. One reason for this might be that companies and employees have frequently entered into section 431 elections (see below), even if only on a protective basis, in order to opt out of the Part 7 regime.

However, share valuation issues were relevant in the recent case of Sjumarken v HMRC [2015] UKFTT 375 (TC). The taxpayer had an interest in more than one of his employer’s incentive plans, but the one which is of particular relevance from the valuation viewpoint was his interest in his employer’s share plan (Share Plan).

After the taxpayer had been made redundant by his employer, certain shares deriving from the Share Plan were allocated to the benefit of the taxpayer.

At the time, these shares appear to have been valued for tax purposes by the employer without reference to any restrictions (resulting in a higher valuation and therefore more tax payable), although the taxpayer was informed by his employer that restrictions continued to apply to at least some of the shares. Evidently, there was some confusion over the extent to which (if any) restrictions continued to apply, and, if so, how this would affect the valuation process. The tribunal concluded that the relevant provisions in the Share Plan were unclear, and that, in practice, the shares were subject to restrictions and should therefore be valued on that basis.

This case is instructive on the following points:

1.       It is crucial that share scheme documents should be clear and unambiguous, and that individual arrangements for particular employees should be communicated fully and clearly to participants, so as to avoid lengthy and time-consuming arguments further down the line.

2.       Similarly, careful records should be kept by the employer regarding the individual arrangements for particular employees, and, in particular, the basis on which valuations are made.

3.       Where restricted shares are involved, a section 431 election might usefully be considered in order to disapply the Part 7 regime. Such an election can sometimes result in a higher upfront tax charge, but it does normally secure greater certainty of tax treatment.

Summer Budget 2015 dividend reform to boost employee ownership?

One of the less anticipated announcements by the Chancellor of the Exchequer in his Summer Budget concerned a major reform in the tax treatment of dividends. These changes will have a significant impact on a variety of individual shareholders, including employee shareholders.

At present, an individual receives a dividend with a notional 10% tax credit. This tax credit is then applied in calculating the individual’s income tax liability. A basic rate taxpayer is not liable for any further income tax, while the effective income tax rate becomes 25% for higher rate taxpayers and 30.56 % for additional rate taxpayers.

The Chancellor proposes that the dividend tax credit will be abolished from 6 April 2016, and will be replaced by a £5,000 annual income tax allowance which applies only to dividends. Above that level, new rates of tax for dividend income will be introduced as follows:

  • 7.5% for basic rate taxpayers
  • 32.5% for higher rate taxpayers
  • 38.1% for additional rate taxpayers

As a result, taxpayers with significant dividend income will have a higher income tax liability than they have at present.

One intention of the reform is understood to be to discourage businesses from incorporating for the sole reason of being able to pay employee shareholders in the form of dividends rather than salary.

Most taxpayers, however, who have a dividend income of less than £5,000 will either be better off or, at the least, no worse off under the new regime. This could, therefore, encourage companies with a broad base of employee shareholders to pay or increase dividends in the knowledge that all shareholders, other than those with sizeable holdings, would receive them free from any income tax liability.

The relevant provisions will be contained in Finance Bill 2016. However, the Chancellor also announced that there will be a period of consultation in Autumn 2015 on the tax treatment of company distributions in general, so it is possible that additional changes will be made before the proposals are brought into force.

3 July is Employee Ownership Day: How might it work in Professional Firms?

The UK’s third Employee Ownership Day is fast approaching, falling on Friday 3 July 2015Employee Ownership Day is intended to raise awareness of what employee ownership means, its benefits and successful employee share ownership models in a range of UK companies.

We take a look below at how a number of law firms are extending their ownership beyond the traditional partners.

  1. A recent high profile example is that of the national law firm, Gateley Plc, which has become the first UK law firm to have its shares dealt in on AIM. In 2014, Gateley took advantage of legislative changes to adopt an Alternative Business Structure (“ABS”) allowing non-lawyers to own, and invest in, law firms. It took the view that the combination of the ABS, the transition from an LLP to a PLC and the AIM listing would present, among other things:
  • Greater opportunities to develop Gateley both organically and by selective acquisition
  • Alignment, through share participation, of employees’ goals with those of the business, and aiding retention of staff
  • A more flexible career structure

It is understood that, while 10% of the shares were sold to clients, 7% of the shares have been reserved for employees.

  1. Australian law firm Slater & Gordon became the first legal practice in the world to apply for a public listing of its shares when it launched on the Australian Stock Exchange in 2007. Since then, it has expanded into the UK legal market by the acquisition of firms such as Pannone and Russell Jones and Walker, and has launched an employee share purchase scheme which is open to all UK staff.

The firm made initial grants of shares to employees on a “matching offer” basis, doubling any shares bought by staff members up to a specified limit.

We understand that the firm also offers long-term share incentives for key staff, as well as the opportunity for employees to receive bonuses in the form of shares rather than cash.

The board of Slater & Gordon has stated that it views equity participation as a fundamental component of an effective executive and employee rewards strategy.

  1. Triton Global is a multidisciplinary professional business operating in the insurance sector. It adopted a corporate structure and became an ABS in 2013.

An initial tranche of free shares was offered to employees at the outset, and two tax-advantaged schemes are now operated for the benefit of employees. Triton reports that, in this way, it has managed to move away from a “them and us” culture, has achieved an excellent rate of employee retention and unwelcome predators have lost interest in the business.

  1. Here at Postlethwaite, we also have adopted employee ownership. Over the years advising clients, we have observed the extent of the positive impact which employee ownership can have on their financial performance, attractiveness as a place to work and long term success.  We also felt it was well suited to our own firm, as we did not want to limit the ownership to only some of our full-time lawyers but preferred to extend it to all, recognising everyone’s contribution.  We have chosen direct ownership by employees rather than indirect ownership through an employee trust, although we think the trust ownership model will often be the right approach for other firms.

Further details about the Postlethwaite model are contained in an article in the 30 June edition of Solicitors Journal which can be found by clicking here

Employee ownership will not be the answer for all professional firms, but it can be worth considering if it might offer advantages compared with a firm’s current ownership structure.

This might involve asking some of the following questions regarding, for example, a traditional partnership structure:

  • Do you think more members of your team could make a greater contribution, and would be likely to do so if they had a stake in the outcome?
  • Are there other people who add value apart from your partners?
  • Are lawyers working part-time less likely to be partners?
  • Are you concerned as to whether there is a willing next generation of people in your firm to take over the ownership and enable existing partners to retire?
  • Would you like to retain more of your people for longer?
  • Would you like to build some new foundations for your firm to help it feel a more positive place to work?

Government policy is now to encourage greater employee ownership across all business sectors.   It believes that this has the potential to increase productivity, build more resilient businesses and foster greater wealth creation which is then shared among those who have helped create it.  Academic evidence suggests a number of strong positive links between employee ownership and company performance.

To stimulate the growth of employee ownership, two new tax reliefs were introduced in 2014.  One gives retiring company owners who sell a controlling interest to an employee ownership trust full relief against capital gains tax, while the other enables employees of a company controlled by an employee ownership trust to be paid income tax-free bonuses.

The number of employee-owned businesses in the UK is now reported to be growing by 10% per annum.

Looking outside the legal profession, some pioneering accountancy firms have now introduced employee share ownership plans, and Grant Thornton has announced plans to become a “shared enterprise”.

We plan to report periodically on further developments in the employee ownership arena, but, in the meantime, you can click on the following link to find out more about Employee Ownership Day on 3 July 2015  

Impact of General Election on Employee Share Schemes

Unsurprisingly, employee share schemes and employee ownership have not figured prominently during the course of the General Election campaign. However, there have been some references in the manifestos of the main UK political parties, and related pronouncements, and it is, therefore, possible to discern trends which might be followed up depending on the political complexion of the Government which takes power after 7 May.

The Conservative-led Coalition Government has already taken significant steps in encouraging employee ownership, so no further measures are expected in this area. However, the Liberal Democrats propose that employees who together own at least 5% of a company should have the right to be represented on the board. Along with the Labour party, they believe that employees should be represented on remuneration committees, where they exist. They also propose the introduction of a two-tier board structure (similar to that widely operated in Germany) which would allow greater flexibility in accommodating employee representatives.

Both the Labour party and the Liberal Democrats have criticised Employee Shareholder status and the indications are that this legislation would be repealed if they were part of an incoming Government. It is unclear, however, how soon a Finance Bill would be enacted, and whether any change would be imposed retrospectively.

Broadly, both the Conservatives and the Liberal Democrats propose to increase income tax allowances and thresholds (although the Liberal Democrats would increase the dividend tax rate for those paying income tax at more than basic rate). The Labour party has made no commitment on income tax allowances and thresholds, but would increase the additional tax rate from 45% to 50%.

Less has been said about capital gains tax, except by the Liberal Democrats who would reduce the annual exemption very significantly from its current level of £11,100 to £2,500. Any unused part of a taxpayer’s income tax allowance could, however, be applied against chargeable gains. The Liberal Democrats would also impose restrictions on the availability of entrepreneurs’ relief.

As of today, the outcome of the General Election remains uncertain. If no party has an overall majority, and deals have to be done between political parties, the above proposals may well be adjusted or dropped, depending on the circumstances. We shall update readers once the position becomes clearer.