Legal structures for employee ownership Contents Introduction The purpose is to explain the different options that are available. Advice should be sought on which is the most appropriate for your venture. The process of achieving employee ownership usually involves the employees either buying the assets and undertaking of the business which employs them, (the target company) or the employees purchasing the shares in that business, directly or indirectly. There are advantages and disadvantages to each option which should be explored with advisers. Company limited by shares In a purchase of a small company the employees may expect to own all the shares. Where the purchase price is high and there are a larger number of employees the employees may establish an employee benefit trust which also becomes a shareholder in the new company or they may seek an outside shareholder. Less frequently, the owners might facilitate a purchase by selling their shares in stages, with a majority of shares passing to employees at the beginning. Some of the employees will usually become directors of the company, and in larger companies non-executive directors may be appointed. Retiring owners may be asked to stay on as directors for a year or so after selling the business to assist in an effective transition. There are two common types of shares - ordinary shares and preference shares. Ordinary shares usually carry one vote for each share. Their value depends on the size of the shareholding compared with the value of the company as a whole. Preference shares have a fixed value. They usually have preferential rights to a dividend and to repayment. Preference shares are often considered as a loan in the form of shares. They are more commonly used in purchases of larger companies. Industrial and Provident Society Company limited by guarantee Partnership Limited Liability Partnerships Employee Share Ownership Plan
(ESOP) There are two principal elements to an ESOP - a Share Incentive Plan and an employee benefit trust. Either can operate independently without the other. They can also be used together. A Share Incentive Plan might be more appropriately called a share distribution trust since its purpose is to put shares into the hands of employees. A Share Incentive Plan can simply be used to incentivise employees without connection to a succession strategy. A Share Incentive Plan is allocated profits from the company which uses the money to purchase shares. The shares can be purchased from existing shareholders or by the issue of new shares. The shares are allocated to employees in accordance with a formula agreed by the company with the Inland Revenue. As part of a succession strategy a Share Incentive Plan might be introduced by retiring owners to incentivise employees before a sale as well as to provide a mechanism for the dilution of their shareholding. It might also be introduced by the employees' own Newco so that new employees of Newco can become shareholders. It can also be used together with an employee benefit trust. A Share Incentive Plan has an obligation to distribute shares to employees. It cannot hold shares collectively on behalf of employees without distributing them. However, since 2002 it has been possible for a Share Incentive Plan to obtain a block of 10% of the shares in a company and distribute these over a period of 10 years. An employee benefit trust is another trust whose purpose is to hold shares on behalf of employees and to facilitate their purchase or allocation to employees. It can therefore be used as part of a succession strategy in companies, particularly those with more than 10 employees. One of the differences between the employee benefit trust and the Share Incentive Plan is that the employee benefit trust can borrow monies to purchase shares from the retiring owners. Co-operatives A common ownership co-operative is one which is controlled by its members (in this case the employees) and the assets of the business may only be used to further the objects of the business, although members can receive a distribution of profits. On winding up, the assets must be donated to another common ownership business rather than distributed amongst the members. Common ownership co-operatives can be registered as companies limited by shares and industrial and provident societies but more frequently they are registered as companies limited by guarantee although this is less tax efficient than companies limited by shares and industrial and provident societies in profit distribution to employees. Share buy back If the target company has been trading profitably for some years an alternative way to reduce the purchase price is for the existing shareholders to make a pre-sale dividend or re-purchase of shares. This results in a pound for pound reduction in the purchase price. Under a re-purchase of shares a company purchases its own shares out of distributable profits. Not all the shares are re-purchased in this way, but simply an amount which uses up some of the distributable profits. The value attributed to the shares will relate to the purchase price which has been agreed. It then becomes a question of cash flow for the target company as to whether it has the cash to make the payment. A purchaser who agrees to the cash balances of the target company being used in this way may require a working capital facility as a consequence. Alternatively, the company may need to borrow money to fund the purchase. The owner who sells the shares of the company in this way may be subject to capital gains tax on the disposal of the shares. But this may be reduced through Taper Relief and reduced or relieved by a shareholder’s annual exemption. The Idea So far as the employees of a business is concerned a stakeholding relationship can involve:-
Many of these relationships are organised through
trade unions on behalf of employees. Employees as shareholders Sometimes companies will offer the shares to employees for free through what is called a profit sharing scheme. The shares can become an asset for employees which they can sell at a later date. This is the most usual route for employees to become shareholders. Companies which are moving to a listing on the Stock Exchange often issue shares to employees on a listing or make them available for employees to buy at a discounted price. Occasionally opportunities arise for employees moving from the public to the private sector to obtain a stake in their company. This happened particularly with the bus industry where local authority companies became private companies. Trade unions in this industry organised themselves so as to ensure that their members benefited from privatisation. Many bus companies still have employee shareholders, and some have employee directors even though the employees no longer hold a majority of shares. Exceptionally employees may be asked to take salary cuts or other benefits, or take a wage freeze, in order to ensure the survival of a firm. This should not be done lightly or for free. Obtaining a shareholding in the company is a way of trading one's loss of benefits for the possibility of a gain in the future. Examples of this have not occurred in the U.K. but have occurred in the United Sates among some airline and steel companies. Risks Rewards Future Developments Employee Benefit Trusts and Share Incentive Plans It is still worth referring to the Employee Benefit Trust in order to understand its use in transferring a business to the workforce and perhaps some day effective lobbying might reintroduce the tax relief in a way which encourages broad employee share ownership. Employee Benefit Trusts Tax relief on payments to an employee benefit trust was based on the tax principle that encouraging the motivation of employees is an expense of the business, which may be seen as something like employee remuneration for corporation tax purposes. By virtue of decisions of the courts over several years where a company made a payment to a trust for the benefit of employees (EBT) the payment could be deducted in the calculation of corporation tax. The first EBT’s were known as case law EBT’s. Since there remained a degree of uncertainty whether the Inland Revenue would accept payments made by a company to an EBT as a tax deductible expense, the Government introduced its own form of EBT in 1989 which was known as a QUEST or Qualifying Employee Share Ownership Trust. Relief for contributions to a QUEST was withdrawn in relation to financial periods beginning on and after 1 January 2003 and it is therefore unlikely they will be used much in future. The Current Situation An employee benefit contribution is defined as a payment of money or transfer of an asset to a third party (eg the EBT) who is entitled or required under the terms of the Trust to hold or use the money or asset for, or in connection within, the provision of benefits to employees of the employer. Qualifying benefits are provided if there is a payment of money or transfer of assets (eg shares) that gives rise to both a charge to Income Tax under ITEPA 2003 and National Insurance contributions. In other words a company can get tax relief on a contribution to an EBT if the EBT pays out a taxable benefit by the transfer of shares or gift of money to an employee. Contributions to a Share Incentive Plan (SIP) The company must ensure that the Plan is approved by the Inland Revenue before any shares are acquired by the Trustees or distributed to employees under the Plan. It can have up to four features: A SIP may provide for the trustee to award qualifying eligible employees free shares. Eligible employees may also permit deductions from their salary to be used to acquire partnership shares. The trustee, if it receives relevant monies from the company, can acquire shares and make additional awards of up to two free matching shares for every one partnership share acquired. The tax investment of dividends on plan shares may be used to acquire further shares, dividend shares, to be held in the Plan. The purpose of this scheme is to encourage wider employee share ownership of a company. Contributions from the company to the Trust may be deducted for the purpose of calculating Corporation Tax on the profits of the trade carried on by the company. The Trust can only use the monies which it obtains from the company to buy shares in the company and is required to distribute those shares to employees. The shares must be offered to employees on similar terms. The shares acquired under the Plan must be distributed to employees which means that it is not a vehicle for collective ownership. Acquisition of 10% Interest in the Company by the
SIP From 6 April 2003 a company is allowed a deduction in its liability to Corporation Tax for a contribution made to a SIP which is used to acquire shares from anyone other than a company. It is necessary under this relief for the trustee to hold shares amounting to not less than 10% of the ordinary share capital of the company at the end of 12 months from the date of acquisition of the shares. This would therefore permit payments from the company to the SIP over two financial years towards the acquisition of these shares. It is important that at least 30% of the shares acquired out of the contribution to the Trust by the company have been awarded under the SIP within five years from the date of the acquisition of the shares. All of the shares acquired with the contribution must be awarded within 10 years from the date of that contribution.
|