New Lower Exemption for Employee Shareholders

The take up of employee-shareholder status has been somewhat lower than the government hoped for. And the recently introduced restriction to the amount of capital gains tax (CGT) exemption is certainly not going to help.

The basic idea is that an employee-shareholder receives tax-advantaged shares in exchange for giving up certain employment rights. The employee-shareholder must receive shares in their employing company with a minimum value of £2,000, with these shares free of tax and national insurance contributions. There is no upper value for the shares which can be acquired, but the excess value over the £2,000 limit is taxed as earnings. The employee-shareholder then benefits from a CGT exemption on the disposal of up to £50,000 worth of shares. The shares are valued at the time they are received by the employee, and the exemption would previously have applied regardless of their increase in value – even if sold for millions of pounds.

However, the amount of exemption is now subject to a £100,000 lifetime limit where shares are acquired under an employee-shareholder agreement entered into on or after 17 March 2016. Any past or future gains arising from prior shareholder agreements do not count towards the £100,000 limit. For example, an employee sells £50,000 worth of these employee-shareholder shares with a gain of £250,000. If the employee-shareholder agreement was entered into before 17 March 2016, the £250,000 gain would be exempt from CGT. If the agreement was later, £150,000 of the gain would be taxed.

Although employee-shareholder style contracts have not been widely used by rank and file employees, they have been more popular for start-ups with high growth potential (so-called gazelle companies). The CGT exemption has been particularly attractive to key employees and directors because they could enjoy the growth in share value in a tax-efficient manner. Such employees would probably not be worried about the loss of some employment rights. Unfortunately, the lifetime limit now reduces the attractiveness of the employee-shareholder regime, even taking into account the reduction in the higher rate of CGT from 28% to 20%. Arrangements may no longer be cost effective where they involve complex share structures.