The subject of profit-sharing schemes was briefly back in the headlines recently when Ed Miliband proposed introducing a plan which made it compulsory for all businesses with more than 50 employees to set up a profit-sharing scheme.
Whilst Miliband’s rationale for proposing the plan is to promote the redistribution of wealth from top to bottom, his method of achieving this objective is fraught with difficulties and potential unwanted side-effects.
For a start, it might lead to businesses not expanding or cutting back on the size of their workforce to ensure that they fall below the 50-employee threshold. They may do this by downsizing their operations, outsourcing various services usually provided by employees or engaging contractors on short-term (non-employed) terms. These measures will lead to greater instability and have an impact on unemployment figures and tax revenues.
It might also put off entrepreneurs from investing further money into a business. Entrepreneurs invest with a view to earning a reward for the risk they are taking. If they have to share that potential reward with employees, who do not share in the risk, it will almost certainly make the investment less attractive.
Contrary to politicians’ apparent belief, I find that businesses very rarely pay out all of their profits to their owners, for a variety of reasons. They may prefer to pay off loans or overdrafts, build up a contingency buffer in case of a downturn in fortunes or save for upcoming capital expenditure projects. If businesses are forced to divert some of these profits to their employees, they are hindered in pursuing these perfectly legitimate and prudent objectives.
Having said all of the above, I am all for employers incentivising their employees by enabling them to share in the success of the business.
There are already a large number of ways an employer can incentivise its workforce.
This might well be by way of a profit-sharing scheme (otherwise known as a “bonus scheme”, but that term is now unfortunately fairly toxic in modern day media and politics), whereby employees are paid a bonus based on the business’s profits or turnover, or the individuals’ own personal performance. These bonuses would usually be paid as supplemental to the employee’s salary, and would be charged to income tax and National Insurance contributions.
There are also a number of share incentive schemes, where, instead of being paid cash, employees are either given shares in their employer company or granted options to acquire shares in the company at some point in the future. By being given an equitable interest in the company, employees are incentivised to increase the company’s value, as they will share in a proportion of that value at some point in the future.
There are a number of HMRC-approved share incentive schemes, both in relation to the award of shares direct to employees (or into an employee benefit trust) and the grant of share options. These schemes enjoy varying degrees of favourable tax treatment on receipt of the shares, on the disposal of them or both.
Indeed, it was only a couple of years ago that the government introduced the new regime of employee shareholders, where employees may acquire an equity stake in their company in exchange for giving up certain employment rights.
The choice of which incentive scheme is best for any particular employer depends on a number of factors, such as the size of the business, the number and diversity of employees, the strategy of the business (for example, whether an exit is likely in the short to medium term) and the maturity of the business (as startup businesses are less likely to want to pay cash bonuses when their profits are better utilised in pursuing their growth strategy).
Read more about the employee shareholder scheme:
- How different businesses have implemented employee shareholder policies
- Legal advice: Considering a staff shareholder scheme?
- Employee shareholder ping pong in parliament
While it is commendable to encourage the distribution of profits to the workforce, I do not believe the mandatory nature of Miliband’s proposal will achieve its intended benefit, as it may stunt the growth of business or inadvertently dissuade businesses from offering a more appropriate form of incentive scheme for their particular circumstances.
Nicholas Gabay is a corporate partner at Thomson Snell & Passmore.
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