RSS feedsEmployee share schemes are a great way to reward employees for their past endeavours and incentivise them to achieve peak performance in their day-to-day roles.
But there is a common misconception that schemes are suitable only for large, quoted companies. In fact, smaller entities are well suited to reward their employees via share schemes, particularly companies that are growing and looking forward to potential transactions that could realise value, such as a flotation or share sale.
Share incentive schemes stimulate individual performance because they create a relationship between the efforts of the employee and the value of their shares. Successful projects can be traced to increased company profits and better sale prospects. Share ownership can provide an employee with an interest in the long-term capital appreciation of the company's shares.
Whereas a bonus scheme arrangement will require the company to pay cash to its employees, a share scheme will involve a dilution or potential dilution of the interests of the current shareholders and, as such, often operate at little, or no, cash cost to the company concerned.
In fact, share schemes can even provide cashflow benefits for companies, since corporation tax relief for certain share acquisitions by employees was introduced in the Finance Act 2003. Bonus schemes, by contrast, provide employees with an interest only in fulfilling the conditions for receiving the 'reward'.
It is possible to structure share schemes in such a way as to incentivise staff to remain with the company and share in the proceeds of business growth, thus rewarding them for their service.
There are several ways of structuring share incentive schemes, broadly spanning share schemes or share option schemes.
Share schemes
Share schemes involve giving employees the right to acquire shares. They may be given the shares for free, or allowed to purchase the shares at a discounted rate. If shares are acquired at less than their market value, there will be an employment income tax charge on the benefit they have received. The charge could be under PAYE, or where PAYE does not apply, tax is not due until 31 January following the end of the tax year.
The up-front income tax charge can be a major weakness of share schemes. One method to deal with the income tax charge is to loan the employee funds that lets them acquire the shares at full price, potentially avoiding or deferring any tax charge due to the full price purchase. Be aware that when the loan is set at an interest rate below the official rate, this 'cheap' loan will be taxed as a benefit-in-kind.
If the employee leaves the company without having disposed of the shares and the loan is written off, there will be an employment income tax charge on the amount of the loan waived. The employee could sell the shares back to the company at the original purchase price or, if this is higher, at current market value, which would enable the loan to be repaid.
Share option schemes
These involve employees being given the right, but not the obligation, to acquire shares at some point in the future at a price agreed now. So, if an employee were granted an option to acquire 1,000 shares in two years time at the current share price of £1, if in two years time the share price is £2 then the employee will be able to buy 1,000 shares for £1,000 and could sell them for £2,000. The employee would, therefore, exercise their option.
Of course, if the share price had dropped to £0.50 then the employee would not exercise their option. The employee will not have any rights over the shares themselves until such time as he or she is entitled to and actually does exercise his or her option. For existing shareholders, there is no dilution of dividends while the employee remains an option-holder.
The employee will not be taxed on the grant of shares, but on the exercise of the option in the same way as a share scheme - to income tax (and potentially NI) on the benefit received, this being the difference between the market value of the shares on the date of exercise and the grant price.
The right to exercise share options often occurs on an event such as a sale or flotation, meaning that the employee will be able to exercise and sell all or sufficient shares to raise funds to pay the tax at that time.
Approved share schemes
There are a number of HM Revenue & Customs - approved share option schemes - Share Incentive Plans, Company Share Option Plans and Save As You Earn Plans. These are generally more suitable for larger employers that wish to make provision of small numbers of shares for a large number of employees. Company Share Ownership Plans are sometimes used (often in conjunction with an unapproved scheme), which allows share options of up to £30,000 to be granted to employees.
There is usually no income tax charge on the exercise of the option shares, only on the capital gains made on their eventual sale. However, the level of administration required and the relatively low level of permitted benefits means that the approved schemes are less well-suited to smaller entities.
EMI Schemes
Enterprise Management Incentive (EMI) schemes are flexible unapproved share schemes offering material tax advantages over other schemes and, as such, are considered to be the most tax-efficient share scheme in practice, where the employer and employee meet the required conditions.
The employee can be granted options of up to £100,000 of shares and, provided they are granted at market value, they will be subject to capital gains tax on the eventual gain made on the shares. This compares favourably with a top income tax rate of 40%, plus a potential combined National Insurance cost of 13.8%. The administration requirements of an EMI scheme are relatively light - a single annual return is all that is needed.
Share incentive schemes allow employers to reward their staff in ways that promote behaviour congruent with the interests of the shareholders. Such schemes can operate at a fraction of the cash cost of a bonus scheme, while providing real and tangible benefits to employees that can often be structured tax-efficiently.
Share scheme Q&A
Who do you want to benefit?
Some schemes require some sectors of the workforce to be entitled to benefit, while many approved schemes require all the workforce to be beneficiaries. Some can be used to reward a limited number of employees.
What happens if an employee leaves?
Many share schemes are written so that any ‘unvested’ benefits lapse on the departure. You can require an employee to sell back shares to existing shareholders or the company itself.
Will the employee be able to realise their investment in the company?
Unquoted company shares are usually an illiquid asset. A takeover or flotation can provide an exit for employees. An employee trust can act as a ‘warehouse’, as a market for the shares and to recycle existing shares.
Adam Kay is a manager in the tax team at Saffery Champness Chartered Accountants
