Don’t forget about employee shareholder capital gains tax exemption

The issue

Employee shareholder status (ESS) was introduced on 6 April 2013 and was a very generous employee share incentive. Broadly it involved employees being given shares with a value of between £2,000 and £50,000 and giving up certain employment rights (such as unfair dismissal) and although the employees would suffer income tax on any value of the shares over £2,000, any future gain would be tax-free. Furthermore, there was a rule whereby a company purchase of own shares (CPOS) is automatically given capital treatment when it is done in connection with an ESS employee ceasing to be employed. Companies Act 2006 was also amended to allow these kinds of shares to be bought back in instalments.

To begin with on 6 April 2013 there was (very generously) no limit on the tax-free gain which could be realised on these shares. From 17 March 2016 the benefit was significantly dampened by limiting the tax-free gain to £100,000 and then the regime was abolished from 1 December 2016.

The fact that ESS is no more does not mean that it should be forgotten about. There are likely to be millions of pounds worth of these shares still in existence.

ESS shares in transactions

The simple message is that there should be no capital gains tax payable on a disposal of ESS shares (possibly restricted to £100,000 for post-17 March 2016 shares). However, shareholders should understand the interactions with other transactions. For example, future tax-free benefits will be lost if ESS shares are involved in a reconstruction (below).

Share for share exchanges are very common transactions and can involve a new holding company being inserted above an existing company as part of a restructuring exercise or a purchaser issuing shares in itself so that a vendor takes a stake in the enlarged enterprise going forward. Unfortunately (and perhaps surprisingly) there is no legislation which allows ESS benefits to flow through into new shares and so ESS shareholders may be left feeling slightly frustrated by such transactions.

The rules work so that any value in ESS shares is ‘banked’ so that any new shares will have a base cost of the ESS shares carried forward. This may be scant reward if HMRC seek to apply a minority holding discount to the ESS shares and so only a proportion of the minority value is banked. Whatever value is applied to the ESS shares at the date of the transaction, any gain will be subject to 20% in the future or 10% in the (rare) cases where Business Asset Disposal Relief (BADR) is applicable.

Our view

There is a danger that the significance of ESS shares will be lost in the mists of time, and it is becoming increasingly likely as time goes on that advisors will not even have heard about them. Any advice involving company shareholders should involve ascertaining the existence or otherwise of ESS shares. Although one would hope that the employees would proactively disclose the nature of their shares because of their ‘exciting’ tax status, some may have forgotten about the pieces of paper that they signed in 2014 and it would be unfair to expect them to understand the implications of a reorganisation (above). Although ESS shares have had no tax advantages for over seven years, let’s not forget about the tax-advantaged shares that are still in existence!