A summary of recent developments concerning Employee Shareholder Status, Capital Gains Tax rates and Entrepreneurs’ Relief.

Employee Shareholder Status (ESS)

The ESS regime was introduced by the Government in 2013.  Under the regime, each participating employee receives at least £2,000 worth of shares in their employer (or a parent company of their employer) in return for giving up certain statutory employment rights (in particular, the right to receive a statutory redundancy payment and the right to claim for unfair dismissal in most cases).  Provided certain conditions are met, there was a CGT exemption on the disposal of the shares provided they were worth no more than £50,000 on acquisition.

However, in this year’s budget, the Chancellor announced that a lifetime cap of £100,000 will apply to ESS shares issued on or after 17 March 2016.  The change will not affect ESS shares acquired on or before 16 March 2016 which will continue to be completely free of CGT on sale.

Capital Gains Tax (CGT) and Entrepreneurs’ Relief (ER)

The Chancellor also announced:

• a reduction in the rate of CGT for higher rate taxpayers from 28% to 20% for disposals on or after 6 April 2016; and
• an extension of ER (which provides for a 10% CGT rate for up to £10m of qualifying gains per individual, subject to certain conditions) to non-employee investors who have held shares in unlisted trading companies (issued on or after 17 March 2016) for a period of three years from 6 April 2016.

WAB Comment

Although ESS was originally intended to incentivise employers (particularly start-ups) to take on new recruits by reducing the costs, administrative burden and other risks associated with terminating their employment in the future, it has been widely used in connection with the issue of shares to senior managers of private equity backed companies.  In practice therefore, rather than ESS being used as a means of freeing employers up from the risk of employment claims, the regime has been used to enable senior employees who were already going to receive shares to benefit from the highly attractive tax benefits.

Indeed, it has become relatively common practice for the statutory employment rights that have been given up to be re-instated as contractual rights in favour of the participants.  As a result, although the substance of the Chancellor’s announcement may have come as a surprise, there has been general speculation for some time that the ESS rules would be subject to change.

Given the new CGT rates (which mean that the maximum benefit from new ESS schemes will be £20,000 per person), it will be interesting to observe the extent to which ESS is used in connection with the implementation of new management incentive plans of private equity backed companies.  ER planning will almost certainly feature more prominently in deal structuring going forward.

The extension of ER to business angel investors will be welcomed in circumstances where the complex rules surrounding the Enterprise Investment Scheme (EIS) prevent the associated reliefs from being available in relation to a particular investment.