Employees of companies under the control of another body corporate – in particular, those controlled by ‘private equity’ funds – are excluded from participating in EMI share option and other tax-favoured employee share plans (SIPs, SAYE schemes and CSOPs). Given the substantial increase in the number of such employees in the UK now that so many British companies have fallen into the partial or entire ownership of such funds, it is suggested that the Government examine how such companies may allow their employees to share in the growth in value to which they contribute through share ownership in a manner which does not put them at a fiscal disadvantage compared with non-employee investors.
It is understood that, if the Government were to afford such a mechanism enabling such employees to participate in a type of share plan which is both relatively straightforward to establish and (crucially) has certainty as to the tax treatment for both employer and employees, members of the BVCA (for example) would be keen to direct or encourage investee companies to establish such plans, given that providing effective incentives to employees is just as much in the interests of the private equity fund as it is in the financial interests of the employees.
The idea of employees benefitting from being joint owners of shares in a company, under a ‘joint share ownership plan’ (or JSOP), was first developed in 2001 and has since been widely adopted by independent companies for allowing selected senior employees to benefit in excess of the limits under tax-favoured plans. The tax treatment of JSOPs has long been settled and accepted by HMRC. A JSOP has the benefit of allowing participants to benefit from growth in value of a share without the need for them to first acquire, and later sell, ownership of the whole of the share. However, at present a company has no certainty as to what is the taxable value of an interest acquired by an employee as joint owner, and the financial risks of discovering some time later that HMRC disagrees with the original estimate of the taxable value of an interest as joint owner of shares is perceived by private equity funds as commercially unacceptable. Leaving all consideration of tax aside, and all other things being equal, the JSOP is, or would be, the mechanism most favoured by private equity funds (when compared with non-tax-favoured share options, ‘growth shares’ or ‘phantom’ share schemes’).
Accordingly, it is suggested that HM Treasury consider consulting upon (with a view to including in the Finance Act 2019) provisions which will allow and encourage wider use of JSOPs in private equity-owned companies, but with strict rules on valuation and subject to a minimum proportion of the issued share capital of the company being made available to all employees through the plan over a given (10-year?) period.
Outline of the proposed ‘employees’ share scheme’
The idea is that, if a company commits to putting a prescribed minimum proportion of its issued ordinary share capital into joint ownership with all its employees (on an individual and ‘same-terms’ basis, subject only to a qualifying period of employment for eligibility), on terms whereby each participant will, for (at least) so long as he or she remains with the company (or group), benefit from all future growth in the ‘pro rata’ value of the jointly-owned shares (i.e. the growth to which they contribute as employees):
(a) the taxable value of such ‘interests in employment-related securities’ acquired by each employee would be treated as their intrinsic value (nil); and
(b) the company could then likewise permit selected employees to acquire such interests in additional numbers of shares of the same class (within a limit) on the basis of the same taxable value (nil).
It is suggested that such limit, on the number of additional shares in which interests as joint owner may be acquired on a selective basis, be a maximum of [8] times the number of shares in which every qualifying employee will acquire an interest as joint owner on that occasion.
To qualify for such favourable treatment:
(i) the shares used must be ordinary shares of the class which is both:
– that which is otherwise owned by the controlling shareholders; and
– the largest class (in terms of nominal value) in issue;
(ii) the ‘pro rata’ value of shares of that class would be determined by taking the ‘market value’ of the whole of the issued share capital of that class (as agreed with HMRC SAV), and dividing it by the number of shares in issue;
(iii) the threshold level, above which participants will be entitled to any increase in value, may be set at or above that pro rata value at the date of acquisition by employees of their interests as joint owners.
The co-owner of the shares would (typically) be the controlling company, but may instead be a trust established for the purpose.
Such an arrangement would:
- allow all eligible employees to participate in the growth in capital value to which they contribute as employees;
- require only minimal changes to current tax rules (with which it is entirely consistent) so as to provide that, if all conditions are satisfied, the initial taxable value of such an interest is deemed to be nil;
- allow employees to participate as actual (joint) shareholders (as opposed to being mere optionholders), and therefore participate in (a pro rata share of) any dividends, and, if the joint ownership agreement so provides, the exercise of voting rights;
[An enhancement might be that, if the whole amount of any dividends on jointly-owned shares are paid to the employee joint owners, all such income would be treated as dividend income of the employee, not as ‘earnings’.]
– (provided the initial market values of the shares is properly identified and agreed at the outset with HMRC SAV) present little or no scope for abuse or ‘tax avoidance’.
Aside from tax, the concept of such ‘joint ownership’ avoids the situation (as under a ‘qualifying Schedule 2 Share Incentive Plan’) in which the company first ‘gives away’ the current accrued value of the shares, only to have to repurchase, or fund the repurchase (through a trust) of that same value when an employee leaves or wishes to sell. Under a JSOP, the employee only ever acquires an entitlement to future growth in value.
If, on the conditional basis proposed, the initial taxable value of the interests is accepted as nil, the only issue to be settled with HMRC SAV is, in the case of unquoted companies, the initial market value of the whole of the shares of that class in issue immediately after any new issue for the purposes of an award under the plan.
If agreed that the IMV of the jointly-owned shares is to be taken to be their pro rata value (i.e. market value determined on a pro rata basis with no discounts for minority interest, lack of marketability etc.), the legislation might also provide that:
– if a participating employee (or ex-employee) realises the value of his interest for a consideration calculated on the basis that the market value of the jointly owned shares is likewise determined on a ‘pro rata’ basis, there would be no charge to income tax on such disposal under Chapter 3D, Part 7, ITEPA (disposal of employment-related securities for more than market value); and
– if the shares are bought back by the issuing company, such a ‘purchase of own shares’ would be treated as a capital transaction and not give rise to a distribution income tax charge (as it would if the interest had been held for less than 5 years).
Practical experience of such ‘joint ownership plans’ since 2001 has been very positive, albeit with the difficulties of determining the initial taxable values of the interests (as joint owners) acquired by employees – exacerbated by the withdrawal by HMRC SAV earlier this year of any facility to agree such values for PAYE and self-assessment purposes.
Encouraging companies to establish such plans by removing that obstacle (identifying the taxable initial value of the employee’s interest) by requiring participation to be extended on an ‘all-employee’ basis would, we believe, prove to be of real attraction to a range of unquoted companies which extends beyond those which presently offer, or could offer, employee share participation.
Crucially, it is estimated that the cost to HM Treasury of facilitating such plans would be de minimis.
David Pett, Tax Barrister 