Budget 2016: chancellor restricts capital gains tax relief on employee shareholder shares.

Employee shareholder status (ESS) was introduced in September 2013 as a new form of employment status. It provides an arrangement for existing or new employees to acquire shares in their employer or the employer's parent company, for no consideration other than for entering into an employee shareholder agreement and the surrender of certain statutory employment rights. The shares, provided they have a value of between at least £2,000 and no more than £50,000 on acquisition, benefit from an exemption from capital gains tax on a future disposal.

The government's stated policy on introducing ESS was "was to reduce regulatory burdens on business, promote business and employment growth and increase the choices available to businesses and employees". 

However, share incentives expert Suzannah Crookes of Pinsent Masons, the law firm behind Out-law.com, said: "In fact it has been the tax benefits which have been a key driver for many companies and employees/directors considering ESS".

"The budget announcement appears to have been a response to the popularity of ESS, which has grown markedly since the election of the Conservative government at the 2015 general election, which removed the threat of its immediate repeal," she said.

The government says it intends this measure will ensure that the potential capital gains tax exemption will not be excessive.

"Clearly the change will limit the attractiveness of ESS somewhat. Where ESS relates to, for example, a new class of share with complex rights and the share valuation and implementation steps are particularly costly, companies may revisit whether ESS is an appropriate arrangement – i.e., are the set up costs and additional complexities worth it, where the potential tax relief is so limited," said Suzannah Crookes.

"Where the value of shares acquired is greater than £2,000, there will be income tax to be paid on acquisition and companies may wish to do some basic modelling to work out whether the costs of the arrangement including the upfront tax cost remains worthwhile," she said.

"ESS clearly still offers advantages – there is after all a £100,000 nil rate band for capital gains tax on disposal of the shares. The first £2,000 of value on acquisition will be income tax free and ESS offers a mechanism to agree share values with HMRC in advance of share issue, which provides certainty in terms of the tax position for individuals and companies alike, and is not available for any "normal" issue of shares to employees and directors," she said.

Some companies who were considering or indeed part-way through putting an ESS arrangement in place will now need to revisit whether ESS is the right way to proceed in their particular circumstances, according to Suzannah Crookes.

"They, and also perhaps some existing users of ESS, may also want to consider whether, in future, other aspects of ESS relief may be more likely to be scrutinised and challenged by HMRC, with a view to limiting the cost to the exchequer. There are some fairly common approaches to using ESS that could fall outside the strict requirements, and that may now warrant more caution than seemed necessary before," she said.