The scheme was announced by Chancellor of the Exchequer George Osborne earlier this month. The Government is now consulting on the employment and company law issues raised by the proposals with a view to allowing employers to offer the new type of contract from April 2013.
The proposed new contract will allow employers to offer shares valued between £2,000 and £50,000 to new employee-owners. In exchange the employee could be asked to give up rights including those in relation to unfair dismissal, redundancy and certain statutory rights to request flexible working and time off for training. Any increase in the value of the shares awarded under an employee-owner contract will not be subject to capital gains tax (CGT). The Treasury will consult on the tax issues raised by the proposal separately.
Tax expert Matthew Findley of Pinsent Masons, the law firm behind Out-Law.com, said that until this consultation was published it would be difficult to assess how tax efficient the proposal would be for employers.
"The Government has made much of the fact that employee-owner shares will be free from capital gains tax," he said. "It has, however, now said that income tax will be due on these shares but has not said when the liability will arise or how it will be calculated. Employers are also likely to have to pay employers' National Insurance contributions. Full details of the income tax and National Insurance position are needed in order to properly assess how tax efficient employee-owner shares will actually be."
Announcing the consultation (22-page / 185KB PDF), Business Minister Jo Swinson said although any type of company would be able to offer the new contract, it was principally intended for "fast growing small and medium sized companies".
"We know that engaged employees are more productive and motivated," she said. "This scheme increases the options for businesses and brings greater flexibility to companies and employees in determining their employment relationship. By responding to the flexible needs of fast growing companies, it will help them take people on, providing a real incentive for employers and employees."
The Government said that employees would be able to "choose" to accept one of the new contracts if an employer chooses to offer it. Businesses will be able to opt out of offering unfair dismissal rights to employees taken on in this way, other than in cases where the dismissal is automatically unfair or was made on discriminatory grounds. They can also opt out of offering rights to redundancy pay, the statutory right to request flexible working and certain statutory rights to request training; and could be able to compel employee-owners to give more notice of their intention to return from maternity or adoption leave early.
Pinsent Masons' employment law expert Christopher Mordue said that the Government was restricted by European law in the rights it could allow employees to 'trade in' in exchange for shares in their companies. In addition, the application of other UK employment laws could render some of the 'protections' offered to employees under the new contracts "illusory" or even "meaningless".
"A woman dismissed for being pregnant, for example, would still be able to sue for a discriminatory dismissal even if her right to claim unfair dismissal had been 'traded in'," he said. "EU law also requires employees to be protected against dismissal for exercising certain rights granted under European Directives, such as taking maternity or parental leave or refusing to opt out of the 48 hour average working week. So it is clear that even the protection from unfair dismissal claims is heavily caveated – even if a claim lacks merit, it can still be made, triggering potentially expensive litigation for the employer."
"A similar problem exists with the idea of employees giving up a right to request flexible working – that is essentially meaningless because a refusal to consider flexible working requests can amount to indirect sex discrimination, so employers would still be open to challenge on that front. The consultation paper suggests that it would not be automatically unfair to dismiss an employee owner for requesting flexible working except if this is made on return from parental leave, but such a dismissal is likely to leave the employer exposed to liabilities for a discriminatory dismissal," he said.
The likelihood was that the scheme could prove to be an "expensive or clumsy option" for employers looking to use it as "insurance against employment claims", he said.
"Employers need to bear in mind that many everyday employment rights won't be affected at all, there will still be a risk of tribunal litigation and the employer may have to buy back the shares on termination of employment, possibly at full value even in cases of gross misconduct," he said. "The cost and administration of providing these shares to every new employee has to be balanced against the real costs of unfair dismissal claims and redundancy payments - most employment relationships don't end in a tribunal claim or through redundancy, most cases settle for far less than the median unfair dismissal award of £4,560 and employees now have to work for two years before being eligible for a redundancy payment or, with some exceptions, to claim unfair dismissal."