A Collective Voice
30 January 2006
First published in Stash Magazine, January
2006.
This article explains a new business idea, that of turning what
are essentially tax driven employee trusts into vehicles to promote
employees’ involvement in the businesses for which they work.
Employee trusts can provide staff with a collective voice for their
benefit and that of the business. A recent research survey
highlights how a collective voice for staff, alongside individual
financial participation and involvement, enhances productivity and
other business outcomes. Recent UK tax changes have removed
the tax incentive for putting new funds into employee trusts.
Employers, trustees and trust administrators are therefore
reviewing existing structures and should consider this collective
voice idea as a new focus for existing trusts, and as a reason for
setting up new employee trusts.
Shared company
Job Ownership Limited (“JOL”) is the UK voice of employee and
trust-owned businesses. A recent report by JOL called “Shared
Company” contains a survey of current research into the performance
of companies with extensive employee share ownership or other
employee financial participation and employee involvement – to
explain how and why this combination lifts corporate performance
well beyond the norm. The survey was carried out by Professor
Jonathan Michie, head of the business school at the University of
Birmingham. The survey covers research into financial
participation of the sort typical in listed companies, where
employees benefit from incentive awards under share and share
option plans. It also covers research into employee ownership
structures, where companies are either wholly or majority-owned by
employees. This type of ownership could be because employees own
shares directly or because employee trusts hold shares, on behalf
of employees or a combination of both these types of
ownership. The John Lewis Partnership is the best known
example of an employee trust-owned business but it is by no means
the only one. The broader JOL network has companies in it
with an annual turnover totalling around £15 billion.
|
Corporate advantages of employee share
ownership
There are a number of elements in companies with some degree of
employee ownership which predispose them to out-perform “classic”
business models. Research from the UK, US and Japan
demonstrates that companies with employee share ownership, or
significant levels of employee financial participation have:
(i) higher productivity and financial performance
(ii) greater innovation
(iii) higher levels of customer loyalty
(iv) lower staff turnover and increased shareholder
returns
Shared Company, Burns, Nuttall, Michie and Postlethwaite,
JOL 2005 p.9
|
Three key drivers
The Shared Company survey refers in particular to an influential
report (Conyon and Freeman, 2001) which shows how essential it is
that financial incentives are combined with employee participation,
so that they work together to improve company performance.
Ownership without participation and participation without ownership
might even decrease performance by frustrating worker expectations
and increasing conflict. The survey, however, draws out a
third essential ingredient in creating successful employee share
plans, the need for an ownership culture encompassing what might be
called a “collective voice”. As well as providing financial
participation and ensuring there are participative mechanisms to
encourage individual involvement in decision making processes
within the business, there also needs to be a collective
voice. This is where the employee trust comes into its
own. Such trusts have scope to represent employees’ opinion
as a whole and so provide a more powerful voice than can be
achieved if each individual employee can only have their say
separately.
Employee trusts
Organisations, such as JOL, have long promoted the vital role of
employee benefit trusts (“EBTs”) in establishing and maintaining
employee ownership structures. Pretty much every employee
owned company has one, even if it is used only to buy shares from
leavers and redistribute them to joiners, rather than hold shares
indefinitely. The Baxi Partnership investment fund has
attracted publicity for financing employee buy-outs at Loch Fyne
Oysters, Learning IT, Woollard and Henry, UBH International and
other companies . Its preferred structure involves a
combination of an EBT and an HM Revenue and Customs (“HMRC”)
approved share incentive plan (“SIP”). This combines the
benefits of collective ownership with the financial and
participative incentives of direct ownership. Academic
research now shows there is good reason to combine both these
elements.
Tax advantaged share plans
Successive UK Governments have done much to encourage direct
share ownership by employees. Since the 1980s employers have
become used to an array of tax advantaged share and share option
plans, aimed at incentivising executives or all employees by
delivering shares directly into the hands of participants. The SIP,
for example, is very tax effective. It permits employees to
receive shares tax free or make tax subsidised purchases of
shares. The enterprise management incentives (“EMI”) share
option arrangement is a very tax efficient share option plan for
those companies and employees that meet the EMI qualifying
conditions. Over 20,000 tax advantaged plans have been
created to encourage direct share ownership. However, no
political party has been enthusiastic about the collective
ownership of shares on behalf of employees. The Shared
Company report suggests this attitude may be misguided.
Tax and EBTs
UK tax law has from time to time given some help towards the
collective ownership of shares on behalf of employees. The case of
E. Bott Ltd v. Price in 1987 heralded a brief golden age for
the employee trust. Confirming earlier cases, a corporation
tax deduction was allowed on general principles for contributions
to a trust established:
“with the object of ensuring that the issued share capital or a
substantial proportion thereof be held by the Trustees for the
benefit of the Company's employees and so that those employees
shall have an interest in the business and undertaking of the
Company a share in its profits (if any) and a voice in the
direction of its affairs”.
The objects of the trust in this case are completely at one with
the conclusions in the shared Company report. All three key
drivers are included.
The company obtained a tax deduction when money went into its
EBT (a so-called up-front tax deduction). There was no need
for any taxable payments or benefits to be made to beneficiaries by
the trustees of the EBT, in order to get the up-front tax
deduction. It was sufficient to show that the EBT
contributions were revenue payments made wholly and exclusively for
the purposes of the company’s trade.
However, as mentioned below, statute now overrides this line of
case law.
There was lobbying to get a statutory right to an up-front tax
deduction for contributions to EBTs. This resulted in the
qualifying employee share ownership trust (“QUEST”)
legislation. In its final form the QUEST could hold shares
for up to 20 years on behalf of employees. An interesting
feature was the requirement for a paritarian composition of
trustees: in which in addition to at least one professional
trustee, one half of the other trustees were employee
representatives.
The QUEST has gone but the Employee Share Schemes Act 2002
(“ESSA 2002”) remains. It has helped boost the SIP’s
collective credentials. This successful Private Member’s Bill
provided confirmation that SIP trustees could be democratically
elected and allows a SIP trust to buy shares with tax deductible
upfront contributions and hold some of them for up to 10 years.
A practical benefit of the ESSA 2002 is the publication on the
HM Revenue and Customs (“HMRC”) web-site of model SIP trust deeds
which include provisions for the election of trustees by staff.
One tax break for EBTs which has survived the test of time is
found in the Inheritance Tax Act 1984. This statute contains
a definition of an employee trust which requires all or most of the
employees of a company (or group of companies) to be potential
beneficiaries of the trust. If the necessary conditions are
met, an employee trust is exempt from the usual 10 yearly charge
that applies to discretionary trusts.
Clamp-down on abuse
Apart from the ESSA 2002 provisions, there is now limited scope
to get an up front tax deduction for contributions to an employee
trust.
The Finance Act 2003 restricts the availability of up front tax
deductions from 27 November 2002. The ruling this year in
Dextra Accessories Limited v. MacDonald in the House of Lords
affects earlier tax deduction claims. The Government is
understandably keen to clamp down on the role of EBTs in mass
marketed tax avoidance schemes. Everyone involved with
the employee trusts and particularly offshore employee trusts has
had to consider the effects of this. Existing EBTs, which
were created for tax planning reasons, may need a new
direction.
New direction
EBTs usually have a great deal of in-built flexibility.
They are drafted in wide terms and trustees typically have an
impressive range of powers and discretions available to them.
The flexibility that attracted tax planners can now be harnessed to
provide employees with a collective voice. The HMRC model
documents mentioned above give ideas as to how trust deeds might be
changed to include employee elected representatives as
trustees. Obviously an offshore EBT will not want to
prejudice its tax status through the appointment of UK trustees,
and a professional trustee company will not want outside directors
in their trust company. Nevertheless other changes can be
made to a trust to turn it into an effective collective
voice. Trustees could, for example, look at including an
express object of promoting an “employee ownership culture” or
“partnership culture” (see inset).
|
Partnership culture
“Partnership culture” means the application of the following
principles:
(a) that the widespread ownership of shares in [Baxi Partnership
Limited (“BPL”)] or in any one or more Subsidiaries by individual
Employees is promoted;
(b) that regard is had to the interests of Employees in
general;
(c) that Employees are encouraged to assume responsibility for
maximising their contribution to Baxi Group having regard to the
interests of future as well as present beneficiaries of the
Trust;
(d) that Employees receive information concerning the major
policies and actions of BPL; and
(e) that opportunities are afforded to Employees whether
individually or through representatives to influence the major
policies of BPL.
Baxi Partnership Limited Trusts Act 2000.
|
So, as an alternative to winding-up EBTs or preserving them as
“legacy” arrangements, trustees should table a copy of Shared
Company for discussion at their next meeting. This may lead
to a new focus for existing EBTs as a collective voice for
staff.
The Shared Company report is available as a free download from
www.jobownership.co.uk.
Graeme Nuttall is a
tax partner at Field
Fisher Waterhouse (www.ffw.com) and managing director of Equity Incentives
Limited, its employee share plans advice service. He
drafted the Private Member’s Bill that became the ESSA 2002 and was
a member of the HM Treasury Advisory Group that helped introduce
the SIP and EMI. He is a co-author of “Shared Company”.