UK: Government announces new employment status: "employee owners"

The Chancellor of the Exchequer, George Osborne MP, announced plans to allow companies to offer shares to new hires in exchange for surrendering certain employment rights ; a consultation document on "employee owners" is expected later this month with the proposal due to come into force from April 2013.

In summary, the proposal

• introduces a new employment status: "employee owners";
• will enable companies to offer between £2,000 and £50,000 of shares exempt from capital gains tax in exchange for employees surrendering various UK employment rights, including unfair dismissal, redundancy, rights to request flexible working, time off for training and rights in relation to return from maternity leave (women will have to give 16 weeks' notice of their date of return from maternity leave);
• allows companies to choose to offer only this type of contract to new employees, but it will be optional for existing employees.

The government press release suggests that companies recruiting "employee owners" will continue to have the option of inserting more generous employment conditions into the employment contract if they want to; although it is debateable to what extent this is likely to be taken up in practice.

Whilst the proposals are aimed at fast-growing small and medium-sized companies, the ability to offer "employee owner" contracts will be available to companies of all sizes. Large companies with a significant number of employees may see this as an ideal opportunity of potentially limiting future costs, and the proposals may be of particular interest to companies held within private equity structures where the initial share price is low, but where there is potential for significant share price growth.

At this stage, limited details are given on critical issues such as whether companies will be required to determine the level of award based on predetermined factors, the type of share which may be issued and whether there will be an ability to impose sale restrictions or forfeiture provisions if the employee leaves or is dismissed. Whether or not the company is able to simply take the shares back or is obliged to buy them back at a reasonable price is fundamental to the reasonableness of this proposal. The likely outcome is that employees will be required to sell back their shares on leaving at a "fair price". This raises significant issues for unlisted companies, for example, those owned through a private equity structure. If such companies are required to undertake a share valuation each time an employee leaves, the cost of this is likely to be prohibitive.

Similarly, whilst generous capital gains tax reliefs are central to the proposals, the announcement is unclear as to whether the shares will be treated as granted for free (and so subject to up front income tax) or whether the employee will be treated as providing value in the form of their waiver of employment rights. Income tax charges on shares in unlisted companies pose particular problems as a "dry tax" charge arises where the employee is unable to sell sufficient shares to cover the liability. Without such income tax reliefs, the benefits for employees receiving awards at the lower end of the scale are limited – there would need to be significant share price growth for such employees to exceed the current capital gains annual exemption of £10,600. A nil rate of capital gains tax is, however, an improvement on the current 10% rate under Entrepreneurs Relief, with potentially fewer conditions to satisfy, and so could result in greater interest in structuring deals to take advantage of this.

The government press release does confirm, however, that where employees receive full capital gains tax relief on shares awarded as part of their contract, this will not affect other available reliefs including those under approved employee share ownership schemes such as the Enterprise Management Incentive.

This controversial and radical proposal has stimulated mixed reactions. The government seek to present it as positive for all: "Get shares and become owners of the company you work for" (George Osborne). However, some view it as a cynical vehicle to allow companies to buy-out employees' rights at bargain prices. Indeed, it could oblige employees to try to calculate the monetary worth of their potential future employment rights against the likelihood of their future employer's commercial success - a difficult exercise. Brendan Barber, general secretary of the TUC, said: "We deplore any attack on maternity provision or protection against unfair dismissal, but these proposals do not look as if they will have very much impact as few small businesses will want to tie themselves up in the tangle of red tape necessary to trigger these exemptions."

Without adequate safeguards, this would appear to introduce Adrian Beecroft's divisive proposal to introduce "no fault" dismissals: an idea which the government announced it would not pursue.

If companies do not operate a clear policy of offering this type of arrangement to all staff, there is a risk that it could itself give rise to discrimination claims. Particularly, if one considers that statistically it will be women who are more likely to be impacted by giving up rights to request flexible working. Whilst avoiding unfair dismissal claims, the proposal could lead to a greater number of discrimination and whistleblowing claims from "employee owners" seeking redress from a former employer. Further, the status of these "employee owners" is currently unclear in relation to other employment protections: the proposal seems to undermine the fundamental protection against unfair dismissal and a right to redundancy payments which are currently mandatory employment protections granted to all employees working in the UK.