Corporate Governance and Tax Implications

17 August 2009 Nick Wagstaffe

Allowing employee involvement in a company’s corporate governance can prove beneficial in motivating staff but as Nick Wagstaffe of Rickerbys explains, it pays to be aware of the details.

As CBI president Helen Alexander recently noted, the economic climate has encouraged a great deal of imagination over the means by which to keep staff employed and at the same time ease cash constraints of the employer. Examples include job sharing, reduced and flexible time and unpaid leave.

Against this background, it is also interesting to reflect upon the UK’s sophistication in encouraging employee participation in ownership of private sector employers. We have an established culture of employee proprietorship and much of this has been driven by tax-based encouragement. Think of pretty much any FTSE 100 organisation and within the parameters accepted by institutional investors you will find a range of tax-favoured and non tax-favoured share-based plans available to incentivise and reward not only the board and senior executive teams but in all likelihood the entire workforce as well.

The growth of employee participation in the ownership of their employing company is by no means confined to publicly traded organisations. For those who do their weekly shop at Waitrose, they will probably like to go there at least in part because of the extraordinarily apparent contentment of the shop staff. That is because John Lewis is an organisation steeped in a culture of employee ownership.

There are four key areas to think about: motivation; implication; implementation; and, as with most things in life, taxation.

The motivation hitherto will certainly have been to create an incentive, which inevitably translates to a question of extra money in the bank, but is also motivational in the sense of pride, connection and proprietorship. It will not escape anyone’s thinking that the potential for future financial reward through a share in the ownership may also be used nowadays as a means to compensate for diluted salary costs in the present.

Things to consider

In terms of implication for the employer, there may be concern among unquoted companies that allowing employees into the shared ownership will give them a voice in the governance of the business. That may be true, particularly where the motivation is toward a genuine employee participation culture, but it does not have to be the case. First, unless extremely generous awards are made, the employee group will not be in a position to make appointments to the board. Second, it is possible in some employee share-based incentive structures to exclude voting entitlement and therefore to confine the benefit to the purely economic ones of, hopefully, dividend and capital growth. Note, however, that excluding voting entitlement will adversely affect the availability of entrepreneurs’ relief on a later disposal for those who would otherwise qualify.

A second implication, which it is vital to deal with well (particularly in the private company environment), is to make sure that the incentive structures avoid employee shareholders and optionholders being able to hold the majority shareholders to ransom when it comes to a planned sale of the business. This can easily be avoided, but is a detail that must be dealt with from the outset.

"Implementation and taxation must be considered together."

A third implication that it is vital to protect against is that where the employee shareholder or optionholder later leaves his or her employment. The employer’s attitude to the employee’s continued benefit from participation in the plan will very much depend upon the circumstances. Some employers may say that when an employee leaves, whatever the circumstance, his or her benefits in the scheme are lost.

Others may say that, for instance, he or she who has fallen seriously ill and is no longer able to work should not suffer a loss of benefit in the scheme in those circumstances. None, however, would allow continued benefit where an employee has resigned and joined a competitor. These and other circumstances of employment cessation can all be finessed in the scheme structure, but it is again vital to do so at the outset.

Implementation and taxation must be considered together. The type of participation structure a business uses will in part be driven by taxation considerations. There are various participation schemes (company share option plans; share incentive plans; savings related share option schemes; enterprise management incentive schemes) which have tax-favoured status, both for the employee and the employer.

And then there are schemes that have no favourable tax treatment. It will be no surprise that those which are tax favoured have features which limit the amount individually and in the aggregate may be made available to employees and have other constraining features. Nevertheless, they are valuable tools in employee motivation and reward and can be supplemented with non-tax favoured schemes where desirable.

So, there are benefits all round to the use of employee share based incentive plans, not least of all in these difficult trading circumstances, a means to provide, one hopes, some future benefit in return for some payroll savings. And they do not need unduly to tie the hands of owner managers.