Bates Wells Braithwaite response to HM Treasury Consultation Supporting the Employee-Ownership Sector September 2013 contact: Jonathan Morris Senior Associate, Corporate and Commercial Department E: j.morris@bwbllp.com T: 020 7551 7635 2-6 Cannon Street, London, EC4M 6YH Tel: +44 (0) 20 7551 7777 www.bwbllp.com 1
Contents 1. Introduction... 3 2. Summary of BWB s relevant practice areas, experience and client base... 3 3. Background... 4 4. Key theme of our response.... 4 5. Our main points..... 4 6. Commitment across Government......5 7. Responses to Consultation Questions... 6 8. Conclusion...11 2
1. Introduction We appreciate the opportunity to submit a response to the Treasury with respect to the government s pledge to support the employee ownership sector. Should you wish to discuss our response further please do not hesitate to contact Jonathan Morris at j.morris@bwbllp.com or on 020 7551 7635 who will be happy to talk with you further. 2. BWB s relevant practice areas, experience and client base BWB was founded in 1970 by Lord Phillips of Sudbury. It is a full service commercial law firm, based in the City of London, serving a wide range of charities, not-for-profits, membership organisations, social enterprises, non-departmental public bodies, commercial entities and private individuals. We stand out as a law firm combining practical, commercial legal expertise with the deep understanding of the third sector that comes from working with more charities and social enterprises than any other UK firm. We have the largest dedicated charity, social enterprise and not-for-profit team in the UK with some 30 lawyers, including ten partners. We are also ranked in the major UK legal directories for our excellence across many of our specialist practice areas. Chambers UK rank us alone in the top tier for our work for charities and social enterprises and Legal 500 rank us jointly in the top tier. BWB is also ranked in first place by the CaritasData Top 3000 Charities, acting for 75% more charities in the top 3,000 (by size) than any other law firm. Legal 500 has written of BWB as a class act being second to none in terms of experience, wisdom and knowledge. The firm has grown consistently over the years. In particular, our corporate and commercial team has expanded significantly. Our strength is advising large public benefit organisations with significant commercial activity, property portfolios and complex regulatory and governance structures. Our experience enables us to provide strategic advice in a straightforward way. We are proud of our reputation as being green light lawyers who tell clients how to achieve their objectives. BWB has a wealth of experience in advising entities on ways to involve employees in the equity and success of business. In particular, we have been involved in implementing the government s mutualisation agenda: we are a leader in the field of transfers from public sector to mutuals and social enterprises and we have supported 11 organisations under the Cabinet Office s Mutuals Support Programme and 27 consortia bidding under the restructure of the National Offender Management Services. We have also given legal and commercial advice on many other mutualisation and spin-out projects. We continue to be thought leaders on mutualisation and have lectured internationally and domestically on the subject of outsourcing through mutualised joint ventures. 3
3. Background to the consultation The UK government announced in the 2013 Budget that it will provide 50m each year from 2014-2015 to encourage and support the creation and growth of employee-owned companies, in particular through two tax reliefs. This follows the independent Nuttall Review of Employee Ownership in 2012 which concluded that employee ownership can produce a number of micro- and macro-economic benefits, including faster job creation, resilience during the economic downturn and increased commitment from staff. The Department for Business, Innovations and Skills (BIS) began raising awareness of employee ownership as a business structure on the back of this review. This consultation focuses on the government s proposal for a capital gains tax relief, which would apply when the controlling share of a business is sold into an indirect employee ownership structure. The other tax relief being considered is an income tax and national insurance contributions exemption. This would allow indirectly employee-owned companies to pay their employees a certain amount each year free of income tax and national insurance contributions. There would also be an employer national insurance contributions exemption for the company. 4. Key theme of our response As we have pointed out in section 2, BWB has advised many clients on employee ownership. We are excited about the opportunities that employee ownership can offer to companies, individuals and to the wider economy and we have seen, in practice, the benefits that can be derived from employee ownership. Therefore, the overriding theme of our response is that we are supportive of the government s attempts to increase employee ownership as it creates a happier more efficient work place with lower staff turnover. 5. Our main points Our responses to the specific questions set out in the consultation are below. However, there are some important principles that we would also like to emphasise in relation to employee ownership. It is more important for employees to get a financial stake in the business rather than voting control. Although employees will need to have some form of representation at board level, the management team will generally need to be able to run the business independently especially in cases where employees are unlikely to have specific 4
management expertise. We do however, strongly support any attempts to provide employees with power to influence the way their employer is run. We believe that the threshold for capital gains tax relief should be as low as 25% to ensure that businesses can attract investors. Employees are unlikely to be able to inject capital into their business, so unless a business is self-sufficient or able to borrow, they may well need a partner shareholder. Potential partners may be deterred if they are only able to obtain a minority stake in the business. There should be full capital gains tax relief on the part of the company that is disposed to an employee benefit trust (EBT). The relief on the remainder depends on the level of employee ownership. If 75% of the company is EBT owned, for example, then there should be full relief on the whole sale value of the business. If the EBT owns 50% of the company, then we would recommend 75% relief. If the EBT owns 25% then we suggest that the relief should be 50%. The aim is to encourage higher employee ownership but to give tax breaks to those that want some employee ownership. We would urge the government to think about considering community members or customers as well as employees for the purposes of capital gains tax relief on transfers of shares. We at BWB have worked with several such examples, from community wind farms to leisure trusts, children s nurseries and mental health trusts. The government should consider some form of associated inheritance tax relief that makes transfer to an employee benefit trust more attractive than a trade sale. 6. There must be commitment across government Commitment to increasing employee ownership needs to be made across all government departments if companies are encouraged by one set of incentives to move towards employee ownership only to stumble across other barriers put up by another department, then the policy will fail. So it is important that other tax barriers to this type of model are removed. In particular, we suggest: A safe harbour from the transaction in securities legislation for transfers to employee benefit trusts which qualify for capital gains tax relief. We have had experience of a clearance initially being refused by HMRC in a situation where the sellers genuinely wanted to transfer ownership to an employee benefit trust, albeit in two stages. In the end HMRC was convinced of the bona fide commercial nature of the transaction and clearance was given, but our sense is that generally HMRC looks very closely at the transactions in securities rules on any sale to an employee benefit trust; it would be useful to have some clear parameters where taxpayers and HMRC accept that this should not be an issue. An exemption from the loans to participator rules for loans made to employee benefit trusts in order for them to fund the acquisition of shares where such acquisition qualified from CGT relief. Under current rules where the acquisition of the shares is funded by the company making a loan to the EBT, 25% of the amount of the loan will need to be lodged with HMRC until the loan is repaid (assuming that loan is still outstanding 9 month after the year end). On the basis that the vast bulk of 5
EBT acquisitions are likely to be funded by the company in some way this can add a huge additional cost which may in some cases mean that the viability of the transaction is affected. These rules are complex but in essence they are there to stop shareholders taking loans rather than dividends. An exclusion for loans to EBTs would be welcome in this context but also in other situations where a company wishes to fund an EBT and there would seem to be no evil to address. Stamp duty relief on acquisitions by the trustees. If there will be a relief for the seller it may be sensible to reduce the costs of the transaction by also creating an exemption from stamp duty as this gives rise to an additional 0.5% cost for the trustees. Some form of associated inheritance tax relief which would provide for individuals to continue to benefit from business property relief on assets representing the shares for a period of time after the transfer. Loss of business property relief could be a significant factor in discouraging the use of employee benefit trusts as part of business succession planning. It would also make a sale to an employee benefit trust more attractive than a trade sale (a sale to a competitor business) in the same industry. We also believe that the capital gains tax position of sales of shares by the employee benefit trust as part of a sale of the whole company should be considered. If employees participate in the company through the medium of EMIs (employment management incentives) they would qualify for entrepreneurs relief and we question whether it would be appropriate for entrepreneurs relief to also be available on sales by the employee benefit trust. The taxation of sales of shares acquired through such options has been improved by recent legislation so that even where the employee does not hold 5% of the share capital (as is required for entrepreneurs relief) he can still pay tax at 10% when he sells the shares. If the idea is to encourage indirect ownership it would seem fair that the employees as a whole who benefit through an EBT should also indirectly benefit from this reduced rate of CGT. 7. Our responses to the questions posed in the consultation Questions 1 to 5 In summary, these questions focus on the respondee s own business. BWB is a partnership and therefore we are owned by senior figures in our business. From our own experience, we know that internal ownership is a successful business model. However, we do not believe our own experiences as outlined in questions 1 to 5 to be directly relevant to this consultation. Question 6 Are you a professional adviser? If so, do you see many indirectly employee owned companies? Do you think this number is likely to increase? What more could be done to increase the number? Will these reliefs help? In our experience, the use of indirect employee ownership models is currently limited. 6
It is more common for employees to be given an interest in a business through share options and similar incentives. In part, this is because there are significant tax benefits available which encourage the use of share options. However, it is also because this model is particularly effective in encouraging employee ownership in companies where the main return will be in the form of capital growth in the shares. We believe it is important that any new incentives to encourage indirect employee ownership sit alongside and can work with existing incentives designed to encourage the grant of share options and other employee participation. Furthermore, any new tax incentives should be flexible and not unduly restrictive in their operation if they are to encourage more employee ownership in the way suggested. The current push by the government to mutualise public services is likely to increase the number of employee-owned entities over the coming few years. This will be a gradual process but we would caution that if the process is overly complex or long-winded, it will not happen. Employee ownership models are relatively rare and the concept has not yet reached mainstream public consciousness, despite high profile examples such as John Lewis. The provision of more support funding, alongside incentives and mechanisms making employee ownership easier and quicker to progress, would increase exploration and take-up further. Question 8 Do you agree that the qualifying criteria [for the tax reliefs] should be expressed by reference to the proportion of shares with voting rights held by an employee benefit trust? Do you agree that the criteria should also look at the trust s entitlement to assets on liquidation or winding up? We agree that the measure of employee involvement should be expressed by reference to the proportion of voting rights and the economic interest of the employees in the company, as these reflect the true involvement of the employees in the company. However, we think that employees are often more concerned with economic involvement over direct voting influence. However it is important that employees are in some way able to influence how the business is run, even if they are not the dominant force. We think economic interest should be measured by reference to entitlement to income as well as capital returns. Question 9 Can respondents suggest criteria by which to exclude companies which are already controlled by employees by reason of their shareholding in the company? We can see that the reliefs should only be available where there is a genuine transfer of interest to employees who are not currently direct or indirect participants in the company. But whilst we can see the need to prevent abuse, we think it is important that any restrictions placed on the companies which can benefit do not have the effect of automatically excluding companies with a small number of employees or where there are a significant number of employee shareholders already. 7
One possibility would be to exclude transfers to employee benefit trusts where a certain proportion of the beneficiaries (say 50%) already have a material interest in the company (material interest being 5%). Many employee benefit trusts already exclude such people in order to fit within the inheritance tax relief for transfers to an employee benefit trust. Question 10 Do you agree that a simple majority of voting power carried by the company s issued share capital (referred to here as 51 per cent ) is an appropriate level of control? If not, please explain why not. 51% is, in our view, a rather high threshold, especially in larger companies where employees could be given a significant stake which is nevertheless less than 51%. As far as the income tax relief is concerned, as the level of benefit which employees can receive tax free is proposed to be capped at a relatively low level, we cannot see that it is necessary to set such a high threshold. We believe a 25% threshold would be more appropriate. However, we appreciate that if the threshold is too low HMRC may have a concern that this will be used to take income in a capital as in most cases the acquisition of the EBT s interest in the company will be financed by the company. We understand that in terms of the capital gains tax relief the intention is to encourage significant transfers into employee ownership. Maybe here it would be appropriate either to have a sliding scale of relief so smaller transfers qualify for reduced relief, or set criteria for relief on the basis that either a certain threshold level of employee ownership must be achieved or the relevant individual must dispose of a certain percentage of their interest. Question 11 Is there a case for allowing the relief to other types of person liable to capital gains tax, such as trustees? In what circumstances would those persons wish to dispose of a qualifying interest in a company to an employee benefit trust? Although most transfers to employee benefit trusts are likely to come from individuals, we can see no policy reason for excluding other taxpayers such as trustees from benefitting from the relief. This would, for instance, enable shares held in a family settlement to be sold to an employee benefit trust. The question of succession planning in family businesses is an important one. Owners who started their businesses in the post-war period will not necessarily have suitable family members to hand them on to, and so the employee ownership route is a natural option to consider. Incentives should therefore mainly be aimed at benevolent family owners that wish to place their business or assets in the hands of a community and/or staff. Question 12 By how much would take-up of the CGT relief be increased if it were available to more than one transferor on the bases described? 8
In our opinion, the relief should be available to controlling shareholders who dispose of their controlling interest over time. In practice, controlling shareholders may not want to transfer their whole interest in a single transaction but would prefer to transfer gradually over several stages or years. One possibility might be for shareholders who dispose of their interest in stages to be allowed to retrospectively claim relief for prior disposals once a certain threshold is reached. This should not be too onerous to administer as the claim would only be made in the year when the hurdle was eventually met. However, we acknowledge that paying tax back may be unappealing to HMRC. We agree that relief should be available where two or more individuals who, taken together, have a controlling interest, and transfer shares to an employee benefit trust. We do not think this should be limited to cases where the individuals are connected e.g. through a family relationship. It is not uncommon particularly in the high tech sector, for example for a group of unrelated individuals to form a company. We can see no logic for restricting the legislation in this way and if the policy objective is to encourage existing shareholders to transfer controlling interests in an employee benefit trust this should apply whatever the existing shareholding structure is. If the relief is limited to people who on their own have a controlling interest it will have very limited application. In our view it would be preferable to restrict the level of capital gains tax relief to a maximum amount per individual or company rather than restrict the shareholders who can participate to individuals who currently have a controlling interest either alone or with family members. This is likely to encourage wider take up. Question 13 Should the CGT relief be available on disposals of unincorporated businesses, as well as disposals of ordinary share capital in a company? How would extending the relief in this way increase the likely number of qualifying disposals? Extending the relief to unincorporated businesses including partnerships would be a good way of encouraging employee participation in such businesses. Unincorporated businesses cannot benefit from the current reliefs offered in relation to share options and some form of indirect participation is the best way of facilitating wider employee participation in such businesses. Question 14 Would any other definition of controlling interest be preferable in connection with the CGT relief? We believe it is appropriate to measure the interest transferred by reference to both voting power and economic interest although, as discussed above, we wonder whether this should look at both income entitlement (ie dividends) as well as assets on a winding up. As discussed above we believe it is unduly restrictive to limit it to single transfers of controlling interests disposals in stages and by a group of individuals should also benefit. 9
Question 15 What do you see as the risks and advantages of the simple 51 per cent definition and any other possible alternative definitions? How would the number of claimants vary with the possible definitions? Please see our comments to 14 above. Question 16 If the government decides to extend the CGT relief to disposals of unincorporated businesses, how should a controlling interest in such businesses be defined so as to guarantee that an appropriate stake in the business is acquired by the trust? We suggest the test should look at the entitlement to income and capital profits of the business and the threshold level should be the same as is set for companies (ie we recommend a level playing field). Question 17 The government is aware that employee ownership has many forms and can include a mix of indirect and direct ownership. An employee benefit trust might hold the economic value in a company whilst all its employees own voting shares (with negligible economic rights), or over a period of time a company might switch from wholly indirect ownership to introduce significant levels of direct ownership. Should the evolution of the form of employee ownership have any impact on the granting of relief on the initial disposal of a controlling interest to the trustees of an employee benefit trust? We believe it is important that the capital gains tax relief is sufficiently flexible to allow a variety of models of employee ownership which would include direct ownership, indirect ownership or a mixture, provided the requisite interest is transferred. Flexibility is important to encourage adoption. There is no policy reason we can see for restricting the relief to indirect ownership models only. Question 18 How should the type of payments that qualify for the new income tax and national insurance exemptions be defined? In our view, income payments up to an agreed threshold should be allowed to be made income tax and NIC free. It is important that the threshold is not set too low as the benefits to companies will be too marginal to encourage significant take up. We would suggest that the upper limit should be set to nearer 3,000 as this is then in line with certain tax favoured schemes rather than the examples in the consultation which are below 1,000. It is also in our view important that the requirements of the payment structure are not too complex and that if there is a requirement that it is profit related this should not be too detailed. As we have emphasised throughout this response, over complexity will lead to less take-up. 10
Question 19 The government expects that, in most cases, payments will be made directly to the employee from the employer company but it is aware that employers may seek to make different arrangements. The government is considering whether the exemptions should apply where the payments are made by the employee benefit trust although it recognises this may involve more complex legislation. If the exemptions were limited to payments made by an employer company would this provide sufficient flexibility? How could the exemptions be effectively extended to payments made by trusts? In our opinion payments from the trust out of income received by the trustees (for example on dividends from the company) should be permitted, otherwise employees will only get a benefit on exit. Question 20 Do you agree that the proposed outline of the way the exemptions will operate is fair and straightforward for the employer to understand and implement? Whilst we can see the need for some anti-avoidance provisions and restrictions to prevent the abuse of these arrangements it is important the provisions are not overly complex and are easy to measure objectively. Companies need certainty that if they make payments, they will fall within the exemptions. 8. Conclusion In conclusion, we think that the government s pledge to support employee ownership is a very positive initiative. However, the measures must be sufficiently flexible and wideranging or the practical challenges of making them happen will fail to deliver on the commitment and vision behind them. 11