Employee share schemes can be a useful way recruit, motivate and retain staff. They are becoming increasingly common in contracts of employment for senior staff – and new start-up companies looking to attract talent.
Merely transferring some shares to employees is rarely the best solution – it dilutes the existing shareholdings and, from a tax perspective, the difference between the market value of the shares and the price the employee pays is usually taxable as income. An unwary employee can take on a major tax liability before they even sell the shares.
There are similar tax implications of giving employees share options in your company (giving the employee the right to buy shares in the company at a certain price at some point in the future). Generally, the employee will be taxed on the difference between the value of the shares when the option is exercised and the price they actually pay.
There are more tax-efficient share schemes are available to certain (often small, fast-growing) companies:
Enterprise management incentive (EMI) share option schemes
The main advantage of an EMI scheme is that it is only the difference between the market value of the shares at the date of grant and the exercise price that is taxed as employment income. Usually, EMI options will be on terms which ensure that the price paid is at least equal to market value when granted to avoid any income tax charge.
These schemes are only available to independent trading companies with gross assets of no more than £30 million and fewer than 250 full-time employees. Companies and employees are also subject to limits on the value of EMI options they can grant and hold at any one time.
Growth Share Schemes
Growth shares enable directors and employees to become shareholders in a company and benefit in the growth of the company, without having to pay for a share at its current value.
There are a number of ways in which these schemes can operate, and they can largely be tailored to a company’s individual requirements.
A key feature of these schemes is that the shares in the scheme only give the employee valuable economic rights once specified growth targets are met. The taxable value of the shares when issued is low or zero, enabling employees to acquire shares at broadly nominal value without incurring an income tax charge.
Company share option plans (CSOPs)
Under these schemes a company can grant employees options over shares with a total market value of up to £30,000. The exercise price must not be less than the market value when the options are granted.
Subject to the company meeting certain statutory requirements, exercise of the options will be free from income tax (provided this takes place at least 3 years after grant).
Save as you earn (SAYE)
These schemes tend to be used only by listed or large private companies.
Under SAYE, an employee is granted an option to buy shares at up to a 20% discount, conditional on their entering into an HMRC certified savings arrangement whereby they contribute between £5 and £500 per month (after tax) to a savings scheme for 3 to 5 years.
At the end of this period, the savings can be withdrawn or used to exercise the option. There are ways of mitigating the Capital Gains Tax payable on any subsequent disposal of shares acquired.
Share incentive plans (SIPs)
SIPs are more suitable for larger, listed, companies. SIPs enable companies to invite eligible employees to acquire shares in the company. SIPs are often referred to as “all-employee” plans because companies must invite all eligible employees to participate.
A SIP allows employees to acquire shares in their employer, or employer’s parent company. The shares are held in a special type of employee benefit trust – a special type of discretionary trust that is used to benefit employees of the settlor company and its subsidiaries. It effectively holds a pool of shares which can be used to satisfy share awards under a share plan.
Where all the relevant conditions are met, and the shares are held in the SIP trust for between three and five years, no income tax arises on the shares, and no capital gains tax is payable while the shares are sheltered in the SIP trust.
Four different types of shares can be used in a SIP; free shares, partnership shares, matching shares and dividend shares.
Phantom option plans
Whilst not a tax-advantaged plan, phantom share option plans enable employers to make cash awards to employees to mimic the benefits they could obtain under a share option scheme. Employer companies can enter agreements to pay cash rewards to employees which are linked to the value of the company’s shares and which can be triggered on the occurrence of certain events (for example, an exit). They are often used by private or overseas companies to grant awards to employees that mirror share options, in circumstances where actual share options are not appropriate or possible. They are generally discretionary plans and are used by public and private companies