What is an unapproved employee share scheme?
An unapproved share scheme provides employees options to acquire a number of shares at a future date at any price specified by the company.
Unapproved employee share schemes can be offered on a selective basis for certain individuals or groups of employees. The ability to exercise unapproved options is often used to motivate personnel to meet performance targets.
When is an unapproved employee share scheme suitable?
As the name suggests, unapproved share options are not approved by HMRC, and as such they generally do not offer favourable tax treatment.
The flip side to operating outside of HMRC’s purview is that unapproved schemes offer a higher degree of flexibility to meet a company’s specific requirements.
Scenarios where an unapproved scheme would be beneficial to a company include where the criteria for an approved plan has not been met, or where a company wishes to grant options exceeding those allowed by approved schemes – in which case, an unapproved scheme can be used in parallel with an approved scheme.
What is the tax liability for unapproved share schemes?
Generrally, provided the option has been exercised within 10 years of its grant, there will be no tax or national insurance charge when the option is granted.
The exercise price can be set below the market value of the shares. However, when the option is exercised, income tax liability is triggered, which may mean the employee has to sell some of the shares just acquired in order to meet this liability. In many cases, the employer will pay the employee a bonus sufficient to fund the income tax liability.
On the disposal of the shares, the capital gain is calculated by comparing the disposal proceeds to the market value of the shares when the options were exercised.
This is a hugely complex area, largely determined by your circumstances and the type of scheme you opt for. We can advise on the most suitable arrangements for your needs, covering all tax issues such as NI charges and corporation tax deductions. Examples of unapproved schemes include (using brief, non-exhaustive descripts):
Growth Share Plans
Growth shares are typically used to reward to key personnel for growth in the value of the company.
Under a Growth Share Plan, the employee is offered equity in the company without the need for upfront investment. The equity however only becomes valuable once the company value grows beyond an agreed threshold, or hurdle’.
Correctly structured, employees will not be charged to income or NICS on the acquisition.
Long-Term Incentive Plans (L-TIPS)
L-Tips are ‘free shares’ awarded to specific employees of meeting specific performance targets. They are typically used to tie the receiving employees to the company for a specified period of time.
L-TIPs are generally administered through a company-funded Employee Benefit Trust (EBT). When an employee reaches their target their shares can be allocated, transferred or sold from the company-funded Employee Benefit Trust (EBT) or the employee becomes beneficially entitled to the shares.
The benefit will be lost if the employee leaves before this point or performance targets are not met.
The employee is generally liable to income tax on receiving the shares. A liability to employee’s and employer NICs may also arise.
Deductions against profits chargeable to corporation tax may be available.
Entrepreneurs’ Relief reduces Capital Gains Tax from 18% to 10% on chargeable gains, after deducting the annual exemption of £10,600 up to a maximum of £10 million lifetime gains.
Once a person has made gains of £10 million no further entrepreneurs’ relief is available.
To qualify a shareholder must own at least 5% of the company’s ordinary share capital and are able to exercise at least 5% of the votes and be an employee of the company. The shares must be in a trading company and the shareholder must have held them for at least 12 months. The 5% holding requirement will often make the securing of ER difficult for an employee shareholder.