An employee share scheme is any arrangement enabling employees to acquire shares in the company that employs them.
Such an employee share scheme might be used to:
- Incentivise employees
- Attract and retain staff
- Facilitate succession planning for existing shareholders
- To enable a management buyout
While a company could issue shares directly to an employee, if they did not pay the market value for the shares, the difference between the price paid (if any) and the market value would be treated as taxable remuneration in the hands of the employee.
The result would be that the employee would receive shares and would have to pay tax but, if he or she does not have the cash to meet the tax liability arising, the employee might have to sell some of the newly acquired shares to pay the tax (if that was even possible since, while there would be a ready market for shares in a large, listed company, it would be difficult or impossible to sell shares in a small, private company). In some circumstances, the receipt of shares might give rise to.
The employee could simply acquire their shares at their market value without giving rise to any further tax implications; however, they would have to pay for the shares out of their post-tax income.
A more tax efficient way of achieving the transfer of shares to employees, and satisfying the objectives above, is to use an approved employee share scheme.
What types of employee share schemes are available?
Employee share schemes are either approved or unapproved.
By approved schemes we mean those recognised by HMRC and carrying certain tax advantages.
- Share Incentive Plans
- Save As You Earn
- Company Share Option Plans
- Enterprise Management Incentives
Any other arrangements are treated as unapproved employee share schemes. There is nothing nefarious about an unapproved scheme. It is not a form of tax avoidance but rather simply one that does not carry the same tax-advantages as an approved one.
Employee share schemes can be further distinguished between those which enable employees to acquire shares outright and those which provide them with options to acquire shares in future. Among the approved employee share schemes, Share Incentive Plans and Save as You Earn schemes allow employees to acquire shares outright, while Company Share Option Plans and Enterprise Management Incentive schemes allow them to acquire options over shares in their employing company in the first instance. That is, in the latter case, they are granted the right to acquire shares at a future date at a pre-determined price, typically subject to fulfilling certain performance conditions.
SIP and SAYE are more commonly employed in larger companies. For owner managed businesses, Enterprise Management Incentives are flexible and by some margin the most popular employee share scheme; there are however some hurdles to meet and, where these cannot be met, CSOP can provide an alternative way to achieve similar objectives, even if the tax benefits are not quite as attractive.
Failing that, a business looking to incentivise its employees might consider other unapproved routes such as joint share ownership plan, unpaid/partly paid shares or “phantom share schemes” which are essentially cash bonuses, taxed as such, but where the value of the cash bonus is tied to the share price of the company.
For SIP and SAYE, the offer must be for all employees to participate in the scheme. EMI and CSOP however can be tailored and offered to key individuals and are therefore more likely to be of interest to a company keen to attract, retain and motivate more senior individuals.
Share Incentive Plans
Shares can be issued under a Share Incentive Plan without any income tax or National Insurance Contributions becoming due, subject to them being kept for 5 years or more.
Provided the shares are kept within the plan, there is no capital gains tax on their disposal after 5 years.
An employer can give each employee up to £3,600 of free shares in a year. Additionally, an employee can buy “partnership shares” out of gross salary, before tax deductions, of up to £1,800 or 10% of income, if lower. Employees can give further ‘matching’ shares where partnership share shares are acquired. Further shares can also be acquired by the dividends paid.
Save As You Earn
SAYE is a savings-related share scheme permitting employees to save up to £500 per month and, at the end of a three or five-year savings contract, use the accumulated savings to acquire shares. The interest and any bonus at the end of the scheme is paid tax-free and there is no income tax or National Insurance liability in respect of the difference between what is paid for the shares and their market value.
There could however be capital gains tax if the shares are then sold.
Company Share Option Plan
A CSOP provides an employee with the option to acquire up to £30,000 of shares at a fixed price.
Under the scheme, there is no income tax or National Insurance Contributions on the difference between what is paid for the shares and their market value at the date of purchase.
There may be a capital gains tax liability on the disposal of the shares.
Enterprise Management Incentives
Employee share options may be granted under an EMI scheme provided a company has assets of £30 million or less.
The maximum grant of share options to any individual employee over a 3-year period is £250,000.
There is no income tax or National Insurance contributions if the shares are acquired for at least the market value of the shares at the date that the option is granted.
There may be capital gains tax to pay in respect of the disposal of the shares.
In addition to having assets of £30 million or less, companies proposing to issue EMI options must satisfy other conditions such as not undertaking excluded activities such as banking, farming, property development, ship building and legal services.
How an employee share schemes can work: an example
ManCoin Ltd is a recently established Manchester-based fintech company. It was founded by John, and currently has three other employees. John recognises that to realise his ambitions to grow the business, he needs more than his and his staff’s existing technical skills including senior marketing and finance expertise.
The company has plenty of interest from potential clients from the outset but, as yet, has received little in the way of income. It is therefore difficult to pay high salaries to attract the right talent to take on these key roles and John is interested in other ways of remunerating key recruits while conserving cash.
Jack and Jill are marketing and finance professionals respectively. As part of their remuneration, John offers them options under an EMI scheme. These will permit them to acquire 10% each of the issued share capital subject to meeting predefined performance hurdles. They will acquire the shares at their current market value, which, as the company while promising, is still young, will be relatively low.
Fast forward three years and the company has expanded rapidly and now has 25 employees. There is interest from third parties in acquiring ManCoin and, after some discussion, an offer that is too good to refuse is received to acquire company for £5 million.
Having exceeded their performance hurdles and become entitled to exercise their options, Jack and Jill exercise their share options immediately prior to the sale, acquiring their respective 10% shareholdings for £1,000 each (being the value of a 10% interest when the options were granted to them on joining the company) and then immediately disposing of them for £500,000 each.
The difference between the acquisition cost of £1,000 and the disposal proceeds of £500,000 is subject to capital gains tax rather than income tax and, as they are employees/officers of the company, and had been throughout the year to the date of sale of their shares, they qualify for Entrepreneurs’ Relief meaning the gains are subject to tax at 10%. Jack and Jill therefore take away around £450,000 each after tax.
If they had received bonuses, the net take-home would have been significantly less, with bonuses taxed, like salary, at income tax rates of up to 45%, and, in addition being liable to employee and employer Class 1 NIC.
Enterprise Tax Consultants can advise on employee share schemes
Employee share schemes are an attractive way for business owners to reward and incentivise key staff.
ETC can assist with all aspects of employee share schemes and tailor scheme suitable for your circumstances. Contact us for a no-obligation initial consultation with one of our chartered tax advisers about the types of scheme available.