lw uk employee shareholder agreement issues

8/10/2019 LW UK Employee Shareholder Agreement Issues

1/5


2/5

Latham & Watkins Client Alert No. 1589 | September 30, 2013 | Page 2

not have relinquished any employment rights). Conversely, if the value is over 2,000, income tax (and

potentially National Insurance contributions) will be payable on the excess.

In addition, the employee shareholder must receive 2000 worth of shares on day one, in a single

allocation. The issue of shares cannot be staggered, nor can an initial grant of shares be topped-up with

a further grant if the initial grant is later determined to be worth less than 2000.

Therefore, any private company wishing to implement an employee shareholder arrangement, likely will

incur costs at the outset as the employer will have to pay for an independent valuation of the shares. The

employer can then submit the valuation to the UK tax authority (HMRC) for their approval. Although the

company need not agree the valuation with HMRC, the authoritys approval will be prudent, providing the

company reassurance that the shares are worth at least 2000 and therefore satisfy the requirements of

the scheme. HMRC has indicated that it will take 10 working days to respond in the case of an approval,

however the period could be longer if the valuation is rejected or is of a complex nature. An approved

valuation will remain valid for 60 days.

Dilution

The requirement that the shares granted to the employee shareholder are worth at least 2000 alsocauses a potential dilution headache. Typically, when granting shares to employees (for example under

sweet equity arrangements) the lower the value of the share the better, as a lower value enables

employers to issue shares to managers at little or no cost and for any subsequent increase in value to be

subject to capital gains tax treatment rather than income tax treatment. However, under an employee

shareholder arrangement, the lower the value of the shares, the more shares an employer will need to

issue to meet the 2000 threshold. Increased shares could lead to material dilution of the companys

other shareholders value. Companies adopting employee shareholder arrangements will therefore have

to balance this dilution risk against ensuring a realistic valuation.

One solution might be to create a new class of shares for the 2000 worth of employee shareholder

shares. These shares would have greater rights and fewer restrictions than the sweet equity, thereby

increasing their value when compared to the sweet equity.

Newly issued shares

The shares granted to an employee shareholder under this new scheme must be newly issued shares.

Therefore, when an employee shareholder leaves employment and is required to sell the shares back,

the shares issued under the employee shareholder agreement cannot be recycled for use under another

employee shareholder agreement. An employee benefit trust (EBT) can be used to buy back the shares

and warehouse them for use in other employee share incentive arrangements. However, (as with any

arrangement involving an EBT) the employer must be wary of impounding the shares in the trust where

they can only be used for the benefit of the beneficiaries i.e.employees, former employees and their

dependants. If a private company chooses to use the new Companies Act provisions, which allow a

private company to buy back its own shares, the buy-back should be approached with care as the

employer faces potential tax hazards if this is not done correctly (in particular the buy-back must occur

after termination of employment). In addition, any shares the company buys back could not be allotted

again under a new employee-shareholder agreement.

Additionally, employers must ensure the shares are issued to the employee shareholder fully paid-up.

However, the first 2000 worth of shares must not be paid for by the employee. For the shares to be

issued fully paid-up the company must have distributable reserves or receive money or moneys worth for

the shares equal to the amount to be paid-up. This contradiction between the new employee shareholder


3/5


rules and established company law appears to be a legislative oversight and we anticipate that the

government will issue new guidance on this point. Employers could possibly argue that the employees

agreement to give up their employment rights comprises moneys worth. However this argument is

untested.

S.431 election

For the purpose of the 2000 threshold, the company must consider the shares actual market value,

taking into account any restrictions on the shares, such as vesting or forfeiture provisions. Employees will

likely want to make a s.431 election (which is broadly equivalent to a s.86(b) election in the U.S.) electing

for income tax purposes to ignore any restrictions on the shares and to pay any income tax (calculated on

the difference between the restricted and unrestricted market value of the shares) at the time of

acquisition. Making this election and paying the income tax on acquisition avoids a potentially greater

income tax charge when those restrictions are lifted. However, this election also means that the employee

will need to find a means of funding the income tax charge on acquisition of the shares, which could be

expensive if the restricted and unrestricted value differs greatly.

This problem can be avoided by using unrestricted shares in the employee shareholder scheme.

However, in practice, most private company employers are likely to want to impose restrictions on theshares. Listed companies (that would be more likely to grant unrestricted shares) are more likely to use

other tax approved employee share schemes that allow greater income tax savings.

Independent legal advice

The employee must obtain independent legal advice on the terms and effect of the employee shareholder

agreement before entering into it. The employee must follow a specific process; taking seven calendar

days to consider the advice before the employee can enter into the shareholder agreement. This process

is likely to be time consuming and potentially expensive for the employer who must meet the reasonable

cost of the advice being provided. The employer should be vigilant to pay only for advice to the employee

on: the terms and effect of the employee shareholder agreement and general advice explaining how

employee shareholder arrangements are taxed as only this advice can be paid for by the employer on a

tax-free basis. In particular, if an advisor began negotiating the terms of an employee shareholder

agreement (for example the good leaver/bad leaver provisions relating to the shares) or providing detailed

tax advice, the employer could not pay for this advice on a tax-free basis.

Will Anyone Adopt the Employee Shareholder Regime?

Time will tell whether the employee shareholder arrangements will be adopted by many employees and

employers as well as how easily the practical issues discussed above can be successfully navigated.

Although the UK government likely did not intend this outcome, we anticipate that employee shareholder

schemes will appeal primarily to senior managers in a private equity buy-out scenario who are familiar

with the concept of share-based remuneration and will appreciate the associated tax advantages. In

particular, the CGT exemption on employee shares valued at up to 50,000 on date of issue will beextremely attractive to senior managers. The employee shareholder regime allows employers to impose

restrictions on the shares issued to the employee shareholder and the employer is free to agree to any

contractual terms around forfeiture of the shares, including when the employee shareholder becomes a

leaver. This flexibility will appeal to investors.

Employee shareholder agreements will be less attractive to junior employees who will want to retain their

employment rights and are less motivated by potential tax savings. Employee shareholder agreements

are also unlikely to be attractive to listed or independent companies that have the option of other HMRC


4/5


approved share schemes that afford greater tax savings (for example, CSOPs, SIPs, EMI and SAYE

schemes).

We anticipate that in a private equity backed, buy-out scenario, the employee shareholder regime could

be used to maximise tax efficiencies as part of any management incentive arrangements. For example, if

companies create a separate class of shares for the purpose of granting the initial 2000 worth of

employee shareholder shares, provisions pertinent to valuation can be baked in to the shares rights so

that the provisions are applicable to both the restricted and unrestricted value of the shares. This

approach will minimise the difference between the restricted and unrestricted values, which in turn

reduces the income tax charge when making a s.431 election. Companies may also consider issuing

unrestricted institutional strip shares worth 2000 in order to ensure that the managers qualify as

employee shareholders. Thus, companies could eliminate the need for a separate valuation process, and

if the shares are unrestricted, eliminate the need for a s.431 election, which would trigger a tax charge on

acquisition of the shares. Such arrangements would not preclude companies using a separate class of

shares in standard sweet equity arrangements alongside the employee shareholder arrangements and,

if properly structured, managers could benefit from the 50,000 CGT exemption in respect of these

additional shares as well.

Conclusion

Integrating the employee shareholder regime into management incentive arrangements will, of course,

require careful consideration of the companys existing share structure and documentation to ensure that

the new arrangements do not cut across existing pre-emption rights or other shareholder protections.

However, with careful planning and execution, we anticipate that the employee shareholder regime could

offer a new means of incentivising key employees in a tax efficient way.


5/5


If you have questions about this Client Alert, please contact one of the authors listed below or the Latham

lawyer with whom you normally consult:

Stephen M [email protected]+44.20.7710.1066London

Sarah [email protected]+44.20.7710.1858London

Client Alertis published by Latham & Watkins as a news reporting service to clients and other friends.

The information contained in this publication should not be construed as legal advice. Should further

analysis or explanation of the subject matter be required, please contact the lawyer with whom you

normally consult. A complete list of Lathams Client Alertscan be found atwww.lw.com.If you wish to

update your contact details or customize the information you receive from Latham & Watkins, visithttp://events.lw.com/reaction/subscriptionpage.html to subscribe to the firms global client mailings

program.
http://c/Users/hpunnone/Local%20Data/Outlook/Temp/[email protected]://c/Users/hpunnone/Local%20Data/Outlook/Temp/[email protected]://www.lw.com/http://www.lw.com/http://www.lw.com/http://events.lw.com/reaction/subscriptionpage.htmlhttp://events.lw.com/reaction/subscriptionpage.htmlhttp://events.lw.com/reaction/subscriptionpage.htmlhttp://www.lw.com/http://c/Users/hpunnone/Local%20Data/Outlook/Temp/[email protected]://c/Users/hpunnone/Local%20Data/Outlook/Temp/[email protected]

lw uk employee shareholder agreement issues

Documents