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Employee Shareholder Contract Status

13 September 2013

From 1 September, 2013 a new employment status has been created (s.205A of the Employment Rights Act 1996). This is that of an "employee shareholder". To qualify the individual must be engaged under the terms of an employee shareholder contract and the employer must give, and the employee must receive, shares in the employer or its parent company. The shares must have a minimum value of £2,000 on receipt and there is no upper value.

There is no income tax or national insurance consequences of the grant of the first £2,000 of shares and no capital gains tax is chargeable when the shares are sold on a subsequent disposal of the first £50,000 of shares.

The new employment status can be offered to both existing or new employees. Existing employees cannot be required to change their employment status.

Employment rights given up by the employee

In exchange for the share benefits, the employee shareholder loses some employment rights:

  • they cannot bring an "ordinary" unfair dismissal claim
  • they are not entitled, if made redundant, to a statutory redundancy payment
  • they cannot submit a statutory flexible working request or a statutory request for study or training
  • they have to give longer notice of their intended return from maternity, paternity or adoption leave.

Save for these exceptions, the employee shareholder has equivalent employment rights to normal employees.

Conditions to secure employee shareholder status

There are a number of conditions that have to be met if employee shareholder status is to be secured. These are as follows:

  • both employer and employee must consent to the new contract
  • the employee must be given fully paid up shares in the employer's company or employer's parent company, and the shares must be worth at least £2,000
  • the individual must not pay for the shares in any way
  • the employer must give the individual a written statement of the particulars of the status of the employee shareholder making clear what employment rights they will not have and other detailed information concerning the rights that attach to the shareholding
  • the individual must receive advice from an independent legal adviser on the terms and effect of the written statement. The employer is required to pay for that advice regardless of whether the individual accepts the job or not. (The cost of that advice is not a taxable benefit)
  • the individual has a cooling off period and cannot accept or agree to an employee shareholder job until 7 days have passed since receiving the required legal advice.

Failure to comply with any of these conditions results in the individual not being an employee shareholder and they will be treated as a normal employee who will be able to bring an unfair dismissal claim. In the event the employee shareholder sells their shares during the course of their employment, their employee shareholder status will not be affected.

Difficulties with employee shareholder status

The new employee shareholder status has not been greeted with any great enthusiasm as there are a number of issues that will have to be considered by employers and employees. The following are important issues:

  • employers have to be limited companies with the right to issue paid up shares and the employer will have to consider fully the consequences of issuing the shares, how they will be valued in the event of sale, what rights will be attached to the shares, eg will they be voting shares and will a dividend be paid in respect of the shares issued
  • the scope of the advice given by the independent legal adviser is not fully specified but presumably must cover both the loss of certain employment rights and the nature of the share benefits granted to the employee, for example are the shares subject to "drag along" or "tag along" rights? 
  • the company is required to explain how the valuation has been reached with regard to the initial allotment of shares and how any restrictions applied to the shares may impact the valuation. Any mistakes on valuation may give rise to claims for those employment rights the employee shareholder was deemed to have given up
  • how are the shares to be valued on termination and will the employee shareholder be permitted to retain the shares will need to be considered. Further, if they are allowed to retain the shares, will this give rise to problems such as minority shareholder claims? Any such restrictions will have to be set out in the written statement.

There are other issues that are not clear which will not encourage the use of the status. For example, if by consent the status changes, and the employee shareholder becomes an employee, will statutory continuity of employment be reinstated? If it does will it run from the date the status changes, or will the employee have to wait for 2 years before obtaining protection from unfair dismissal. It is possible to offer contractual protection to replicate the loss of statutory protection so in the event of redundancy a contractual payment equal to the statutory sum can be paid, but this is not so easy to achieve with regard to unfair dismissal protection.

Will employee shareholder status be used?

Overall the proposed arrangements are not attractive and if they are to be adopted the employee will have to take account of the benefit of the shares and, in particular, the tax benefits of receiving the shares, in light of the rights given up and the costs associated with setting up and supporting the arrangements. The tax benefits are marginal unless the number of shares allotted are significant. Accordingly this status is likely to result in such arrangements becoming the preserve of senior employees to whom the loss of statutory employment rights is relatively unimportant (as their security is delivered under the terms of their service agreement) and where the tax saving is meaningful.

From the employer point of view employee shareholders are still protected from any action that is discriminatory so employers may not see it as a safe route with no risks on termination. 

Given all of these issues, it is more likely this status will become the preserve of tax avoidance arrangements for senior executives in start-up businesses rather than a way of engaging employees as shareholders with a meaningful stake in the future of the business.

For more information please contact Alan Julyan, Partner

T: +44 (0)20 7427 6407