This article sets out the types of schemed available to employers and their key business benefits.
What are the key business benefits of employee share schemes?
The main benefits are financial and motivational:
- Tax and NIC savings. Some types of share scheme attract particular income tax and national insurance contributions (NICs) advantages that can help reduce your business’ employment costs. Corporation tax relief may also be available.
- Employee retention. They can help the recruitment, retention and motivation of high-calibre staff, and the alignment of shareholder and employee interests.
- Conserving cash. There may be less pressure on salaries if a business offers a share plan.
- They provide incentives for employees to meet key business and financial targets.
- Succession planning. Ownership of a business can be gradually transferred to your employees, rather than to new outside shareholders, through awards made under employee share and share option plans.
What are the different types of schemes that are available to businesses?
Some employee share schemes benefit from favourable tax and NIC treatment. There is also a range of other share incentive schemes without statutory tax advantages (also called unapproved or fully taxable schemes), which businesses may find useful due to their flexibility.
Tax and NICs favoured schemes
Enterprise management incentives (EMI) share options
EMI share options are specifically targeted at small, higher-risk trading companies. Certain trades do not qualify, as they are seen as insufficiently risky. EMI options do not have to be offered to all employees and attract a very favourable tax treatment, which will be especially appealing to 40% and 50% taxpayers. There are limits on the value of options granted to each employee and the total value of shares that can be placed under option. The laws associated with EMI options are the most flexible and generous of the UK’s four tax-advantaged share incentive regimes.
Company share option plans (CSOPs)
CSOPs give employees the right to buy shares at a specified time in the future (usually at least three years after grant) at a price which is set at the outset. The employee makes no initial financial commitment or future obligation to exercise the option. CSOP awards do not have to be made to all employees. Listed companies can usually meet the statutory conditions, but private companies need to review the rules carefully. Companies which do not qualify for EMI options may be able to use CSOP options. As for EMI options, there are limits on the value of options granted to each employee, but these are less generous than for EMI options. Again, the tax benefits make CSOP options especially appealing to 40% and 50% tax payers.
Save as you earn (SAYE), sharesave, or savings-related share options schemes
In an HMRC-approved SAYE option scheme, the employee agrees to save a certain amount each month for a specified period, with an approved savings provider. The employee then uses the proceeds of their savings to buy shares. If the employee does not want to buy the shares, they can choose to have their savings and a tax-free bonus paid out in cash instead. Participation in an SAYE option scheme has to be offered to all or most employees. SAYE option schemes and share incentive plans tend to be used more by larger companies, as the administration of these schemes can be quite demanding.
Share incentive plans (SIPs)
HMRC-approved SIPs enable employees to acquire shares (as opposed to share options) in their employing company (or their employer’s parent company). The company can offer partnership shares, which employees buy out of their pre-tax income and/or free shares. The company can also offer additional free shares, called matching shares, to those who buy partnership shares. Businesses can reinvest any dividends on the shares in the SIP in further shares, known as dividend shares, or pay the dividend straight to the employee. Participation in a SIP has to be offered to all or most employees.
Unapproved (fully taxable) schemes
The most common arrangements are:
- Unapproved share option schemes. These are similar to EMI options and CSOP options (obviously, without the tax advantages), but there is greater flexibility in the terms that can apply to the options and shares.
- Nil-paid or partly paid share schemes. These involve the acquisition of shares on deferred payment terms and offer certain tax advantages, but require careful structuring.
- Growth shares. These are a special class of employee share designed to have a low value on acquisition, but entitling the shareholder to a share in any growth in value of the company. Again, they offer certain tax advantages, but require careful structuring.
- Long-term incentive or performance share plans (LTIP/PSPs). Senior executives are awarded shares at nil cost subject to a period of continued employment and meeting a performance target.
- Share matching plans. The executive agrees to buy and hold shares (possibly out of a bonus) and the company matches this with an award of free shares if performance and service conditions are met.
What are the potential problems with employee share schemes?
- Selling a private company. Share incentives need to be carefully structured to accommodate possible future sales of the company. As it is common for share options to be exercised in connection with a sale, suitable replacement incentives may need to be put in place to help retain key employees after the sale. Your business will also need to be careful to avoid losing valuable corporation tax relief associated with share incentives as a result of a change of control.
- Listing a private company. Existing share incentive plans are likely to have to be restructured.
- Leaver’s rights. There are a number of issues to consider when an employee with shares or share options leaves your business. For example, what was the reason for them leaving your business? Their reason for leaving can substantially affect their share plan entitlements and potential risks associated with any dispute on termination.
If you have any questions about the content of this checklist, please contact Rajan Berry.