How do you attract and retain good employees and motivate them to take an interest in the business as if it were their own, all without excessive upfront cost? For many companies the answer, or at least part of it, lies in offering employees a ‘piece of the pie’; a stake in the company through an employee share scheme.
Why use a share scheme?
Share schemes can be efficient and affordable way of attracting, retaining and incentivising employees (often senior executives, but not exclusively). By aligning the interests of the employee with that of the owners of the business, the company hopes to motivate the employee at relatively little cost. Some schemes offer tax relief on gains that offers a further attraction to both the employer and employee.
Types of Share Scheme
Share schemes can be broadly divided into two groups; those that are tax-advantaged and those that are not. We have set out below the main characteristics of the most common types.
Tax-advantaged Schemes
Save as you Earn, sharesave, or savings related option schemes (SAYE)
Under an SAYE scheme the employee is awarded an option to buy shares in the company after a qualifying period of service (which must be no more than 5 years), at an exercise price which can be set at up to a 20% discount to market value at the time of grant of the option. This option is conditional upon the employee entering into a linked savings arrangement with a bank or building society to save up the option exercise price. Money is paid into that account, usually by deductions from the employee’s pay (after tax), over the relevant period.
At the end of the savings period, the employee can choose whether to use the money saved to exercise the option (i.e. buy the shares), or to simply withdraw the savings.
The scheme must be available to all employees.
SAYE schemes can benefit from favourable tax treatment both for the company and the employee, subject to compliance with statutory requirements.
Company share option plans (CSOPs)
Only companies who comply with specific statutory provisions can adopt a CSOP. In brief, these include:
- being either listed on a recognised stock exchange or free from control of another company
- the options can be granted either by the employer company or a parent company (but not over an unlisted subsidiary of a listed company)
- the shares under option must be ordinary share capital.
CSOP options can only be granted to employees and full-time directors, and not to any employee with a “material interest” in the company. Provided these criteria are met, the company is free to choose which employees can participate.
The exercise price of a CSOP option must not be less than market value on the date of grant. Many companies must agree market value with HMRC in advance of the grant.
Although there are few statutory restrictions on when CSOP options may be exercised, beneficial tax treatment does not apply if the option is exercised before the 3rd anniversary of grant (unless the employee falls within the description of a “good leaver” set out in the legislation.
CSOP schemes can benefit from favourable tax treatment both for the company and the employee, subject to compliance with statutory requirements.
Enterprise management incentive (EMI) Scheme
EMI options are aimed at small, higher risk independent trading companies which comply with specific criteria, including having gross assets of no more than £30 million and fewer than 250 full-time employees (or equivalent).
EMI options can be granted through an EMI scheme open to a number of employees, or through a stand-alone agreement with an individual employee.
EMI options can be granted to any employee who works for the company for at least 25 hours per week (or, if less, 75% of their working time) and he does not have a quote material interest quote in the company or related companies. They cannot be granted to non-executive directors or consultants.
The exercise price of option is set at the time of grant and can be at any level (though an exercise price that is less than market value at the time of grant will have tax consequences on exercise of the option)
Beyond a requirement that the option must be capable of being exercised within 10 years of the date of grant and only within 12 months after the option holder’s death, there are no restrictions on the provisions that can apply to the exercise of EMI options. Employers have the flexibility to grant of options that can be exercised after specific vesting period, or subject to certain performance conditions, or on a specific exit event, such as share sale or listing of the company.
EMI schemes can benefit from favourable tax treatment both for the company and the employee.
Share incentive plans (SIP)
With a SIP, the employer company invites eligible employees to acquire shares in that company (or its parent company), which are held in a special employee benefit trust.
Various types of shares can be issued with limits imposed by the relevant legislation.
Provided statutory conditions are met, and the shares are held in the SIP trust for between three and five years, the employee benefits from favourable tax treatment while the shares remain in the trust.
Given the complexity and cost of setting up and administering a SIP, they are generally best suited to larger, often listed, companies.
Non-tax-advantaged share schemes
Non-tax-advantaged share option schemes
An employee share scheme that does not comply with the requirements of a CSOP. Often used by companies as an alternative to, or in addition to a CSOP, for example where the company or individual employee does not meet the qualifying criteria for a CSOP or wants to grant options in excess of the CSOP limits.
There are no statutory requirements on these options, so are much more flexible than a tax advantaged scheme.
Long term incentive plans (LTIP)
Sometimes known as performance share plans (PSPs). An LTIP is a discretionary arrangement, usually operated by a listed company, under which shares or options are awarded to (usually senior) employees at no cost. The award is usually subject to satisfaction of a specific performance condition and shares awarded under an LTIP may be forfeitable or restricted shares.
Restrictions apply as to the source of the shares over which options are granted, as UK companies are prohibited from issuing its own shares at less than nominal value.
The tax treatment of LTIPs depends on the type of award, but is not tax advantaged.
Deferred bonus/share matching plans
Under a deferred bonus plan, an executive’s annual bonus is deferred into shares that are held in an employee benefit trust (EBT). The company may offer a matching award of additional shares or no cost options if specific performance conditions are met.
Phantom option plans
In circumstances where awarding a share option is not appropriate or possible, companies sometimes award phantom share options. These are an agreement to pay a cash award, the value of which is linked to the value of the company’s shares.
Joint ownership arrangements
With a joint ownership arrangement, the employee is granted an immediate interest in shares, but to be held jointly with another shareholder (usually an EBT trustee) the terms of the arrangement can differ, but generally the scheme works so that the employee only benefits if and to the extent the shares increase in value above acquisition value. Because the employee has acquired the shares from any growth in value of those shares is treated as a capital gain rather than employment income and taxed accordingly.
Employee benefit trusts (EBTs)
A type of discretionary trust specifically established to benefit employees and former employees of the company. Often used to provide shares to mainstream share plans and to purchase shares from departing employees.
The tax and company law requirements relating to employee share schemes are complex and non-compliance can have significant adverse effects on the tax treatment of the scheme. You should therefore seek both legal and tax advice before putting a scheme in place.
If you would like more information or to discuss setting up an employee share scheme for your company, contact Rajan Berry.
