Employee Ownership of Law Firms

The Law Society Gazette dated 27 March 2017 includes a feature article on how law firms have been slow to consider employee ownership of their business and may thereby be missing a trick. Postlethwaite is one of the very few firms to have adopted an employee ownership structure. We would be happy to advise other professional firms on the opportunities available and the most appropriate ways of securing the desired outcome.

The article can be found by clicking on the image above

Impact of share restructuring on EIS relief

Enterprise Investment Scheme (EIS) investors should be aware of a recent case which indicates that EIS tax relief can be lost as a result of a share restructuring, even where there is no attempt to gain a tax advantage.

 

 

In the case of Abingdon Health Ltd v HMRC [2016] UKFTT 800, the First-tier Tribunal ruled in favour of HMRC’s decision to withdraw EIS relief following the creation of a perceived “preference” resulting from the introduction of new class of “growth shares”.

As part of the introduction of new employee share scheme, a new class of growth shares was created by the company. The premise of growth shares is that they only participate in future growth in the value of a company above a “hurdle” level (which is often around 5-10% above the value of the company at the time the shares are issued). Since they participate in future growth in value only, the initial market value of a growth shares will be relatively low, and this enables an employee to acquire an equity interest in a tax efficient way with minimal initial outlay. The intention would be that any future growth in value of the shares would be taxable in the employee’s hands as capital gain, rather than income.

In order to protect the interests of the holders of ordinary shares, the company amended its articles of association to include a liquidation preference under which, on a return of assets, holders of ordinary shares would be paid in priority to holders of growth shares up to the amount of a specified hurdle.

In order to qualify for EIS purposes, the relevant shares must be treated as ordinary shares which do not, at any time during a restricted period, carry any present or future “preferential right” to a company’s assets on a winding up.

HMRC guidance on this issue provides that, where a right to a residue of assets on a winding up is purely theoretical (for example, in the case of a very small company, a right of holders of deferred shareholders to one penny per share after the first £20 million has been distributed to ordinary shareholders), the ordinary shares should not be treated as carrying preferential rights (Venture Capital Scheme Manual VCM12020).

In the case of Abingdon Health, HMRC withdrew the EIS relief that had been claimed previously by holders of ordinary shares, and refused EIS relief in respect of a new application for relief by the company on a further issue of ordinary shares, on the basis that the ordinary shares had been granted a “preferential right” on a winding-up.

The key elements in the Tribunal’s decision are as follows:

  • The ordinary shares could not be treated as “qualifying shares” for EIS purposes because they carried a preferential right to assets on a winding up during the restricted period. The Tribunal considered that the preferential right existed whether or not the hurdle was achieved.
  • The preferential right was not purely theoretical, and the company could not therefore ignore it and rely on the exemption in HMRC’s guidance in VCM12020.
  • It was not necessary to determine how likely a winding up might be, since the legislation only considered whether the relevant shares carried preferential rights, and there was no opportunity to consider whether the rights were likely to arise in practice.

The Tribunal’s decision confirms the generally accepted view and makes clear that, even where there is genuine commercial activity, the drafting of the EIS legislation can give rise to, at the least, unintended consequences, and perhaps even traps for the unwary. This needs to be noted particularly where share restructuring or new employee share scheme arrangements are involved. Companies and EIS investors will also be well-advised to consider the published HMRC guidance very carefully in the light of this case.

For companies wishing to combine EIS status on ordinary shares with growth shares, all is not necessarily lost. By giving the ordinary shares a priority right to a capital return on a sale of the company but not on a liquidation, the requirements of the legislation can still be complied with. Many companies are willing to accept this on the basis that a liquidation is very unlikely. We would be pleased to discuss this possibility with any company wishing to consider this approach.

Corporate Governance and Employee Involvement

Cogs Machinery

 

When taking office as Prime Minister, Theresa May stated that one of her priorities would be to tackle “corporate excess”. Initial suggestions included the appointment of employee representatives to the boards of companies, but, once the practical difficulties involved in this were identified, this seems to be have watered down.

 

However, a Green Paper (consultation document) on the subject of corporate governance has today (29 November 2016) been published which addresses:

  • executive pay
  • strengthening the employee, customer and supplier voice
  • corporate governance in the UK’s largest private businesses

Views are invited on the following main topics

Executive Pay

  • how to hold companies to account on executive pay and performance
  • whether investors need to be encouraged to use existing powers
  • effectiveness of remuneration committees
  • better alignment of long-term incentive plans with long-term interests of companies and shareholders

Another measure under consideration is the publication of pay ratios, which would identify the gap in earnings between the chief executive and an average employee. Former Business Secretary Vince Cable proposed pay ratios in 2012, but the idea did not progress since the view was taken that the figures could be misleading. For example, an investment bank would almost invariably have a lower ratio than a retail business with a large number of lower-paid employees. And at a top football club, the employees would usually be better paid than the directors, but this would provide no insight into how well the business was being run.  In addition, a company which outsources most routine jobs is likely to have a lower ratio than one which directly employs the people carrying out those tasks.

Strengthening the employee, customer and supplier voice

  • how to take account of the views of employees, customers and other stakeholders at board level
  • whether any reform should be one which is legislative, code-based or voluntary

It is worth noting that businesses that are substantially employee-owned already provide employees with a significant voice, either at board level or, far more commonly, through an employee ownership trust (EOT) which has regular dialogue with directors. While the subject of employee ownership is outside the scope of the Green Paper, it is a concept which enjoys all-party support and would offer an alternative means of achieving some of the Government’s declared aims.

Corporate governance in the UK’s largest private businesses

  • whether the existing code for listed companies should be extended or a new code introduced for private companies
  • which companies should be within the scope of any new code
  • whether any new code should be underpinned by legislation or be voluntary

Responses to the Green Paper can be submitted before 17 February 2017 to:

Corporate Governance Reform Team

Department for Business, Energy & Industrial Strategy

3rd Floor Spur 1

1 Victoria Street

London SW1H 0ET

You can find a copy of the Green Paper by following this link https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/573120/beis-16-56-corporate-governance-reform-green-paper.pdf

You can find further information about the employee ownership of businesses on our website where you will also find some animated illustrations.

Autumn Statement and Employee Shareholder Status

london

 

On Wednesday this week the Chancellor announced that with effect from December 1st 2016 the Government will abolish the tax advantages associated with Employee Shareholder Status (also known as shares for rights or ESS) as he considers that shares issued to individuals acquiring this status have been used for tax planning purposes.

The effect is that the income tax and NIC relief available on the award of shares to an “Employee Shareholder” will no longer apply, and the capital gains tax exemption on the first £100k of gain on the sale of shares by an Employee Shareholder will also be stopped, in each case for any awards completed after December 1st 2016.  In most cases, this means an immediate withdrawal because an award may only be completed at least seven days after the participating employee has been supplied with the award documents and then taken their own advice.  The Government statement said:

“The status itself will be closed to new arrangements at the next legislative opportunity.  This is in response to evidence suggesting that the status is primarily being used for tax planning instead of supporting a more flexible workforce”

ESS was introduced by George Osborne in September 2013, and involves an agreement between an employer and employee that the employee will surrender certain statutory rights of employment in exchange for free shares worth at least £2,000, free of income tax and NIC on the value of the shares awarded.

One attraction of ESS has been the facility to agree share value before an award with HMRC.  However, this remains possible with discretionary option plans (EMI and CSOP) and all-employee share plans (Share Incentive Plan or SIP, and SAYE options).

If you have been considering ESS for your business and are unsure of what else you can do to put in place an employee ownership or option plan, please do get in touch for a chat and we shall do our best to shed some light for you.

Employee Share Schemes: Successful Outcomes

 

Small Group Workers

We have recently seen equity markets at or near all-time highs, which is good news for equity investors generally. It is, however, especially good news for participants in employee shares schemes whose interests mature at this time.

Earlier this year, it was reported that more than 55,000 Tesco workers would be sharing in a pool of £144.4 million as two of the company’s employee share schemes reached maturity. In simple terms, the amount invested had effectively doubled in value due to the performance of the Tesco share price over the last five years. It was understood that around 10,000 employees saved £50 a month for five years under the save as you earn scheme and would see their initial investment of £3,000 double to £6,000, with the additional benefit of tax relief.

This is especially noteworthy given the current economic downturn and the impact this has had on the Tesco share price. There are obvious benefits to employees and employers in such arrangements, and these share schemes have been known to improve loyalty amongst a company’s workforce.

There are now many similar save as you earn schemes in the UK with increasing numbers of employees taking up the option of putting away relatively small amounts of money each month for up to 5 years.

However, save as you earn schemes constitute only one type of employee share scheme, some of which have tax benefits.

More recently, it has been reported that employees of Royal Mail have become able to sell shares which they had been allocated free of charge under a tax-advantaged share incentive plan. If, however, they delay selling until 2018, they will be able to sell without paying any tax at all.

Additionally, while save as you earn schemes and share incentive plans are more prevalent in listed companies, private companies can also make use of tax-advantaged share schemes, such as the popular enterprise management incentive.

Click here to view an animated introduction to share schemes
You will also find further detailed information about the schemes available on our website here .