An employee share scheme is a way of giving employees a stake in your business. Such schemes are usually set up to improve employee motivation and loyalty, to retain current valued staff, and to provide an incentive for new employees to join.
Different Types Of Share Schemes
There are three main types of employee share schemes.
Under a share award scheme, the employee is provided with shares in the company in which they work.
By contrast, under a share option scheme, an employer grants to an employee an option to buy a specified number of shares at some future time at a price fixed on the date on which the option is granted. Employees can exercise their option to buy the shares after a specified period known as the vesting period. The granting and exercising of share options can be made dependent on achieving certain goals. When an employee exercises their options, they do so at the price fixed at the date of grant regardless of the current market price. They can then keep the shares, or if the company is listed on a stock exchange and the market price is higher than the option price, sell them at a profit. These are the most commonly used type of employee share scheme for private employers.
Finally, share purchase schemes allow employees to: buy shares, save money to buy shares or buy shares for a small deposit, paying the rest at a later date.
What Are The Benefits For Employees?
Employee share schemes are a fantastic way for companies to reward and incentivise employees. They can play a significant part in boosting recruitment and retention, as well as helping to make employees feel part of the company as they will benefit directly from its success. One the most well-known employee share scheme is that run by John Lewis Partnership, where employees are known as ‘partners’ in recognition of the fact that they have an ownership in the business.
Employee share schemes can be a tax efficient way to reward employees and form part of the remuneration package. As shares increase in value, workers benefit from that uplift and they may also receive dividends. If the business has given away shares, or offered shares at a discount, then those financial benefits to employees can be considerable.
Where shares are offered under a scheme approved in advance by HM Revenue & Customs (HMRC), the employees would also get significant tax advantages- see below.
Tax-Advantaged Share Schemes
HMRC-approved share schemes have significant tax advantages for both employees and employers. Share option schemes are used more frequently as there will usually be no income tax charges arising until the option is exercised by the employee whilst the direct award of shares can result in an upfront income tax charge.
In the UK, shareholders will always be subject to capital gains tax, normally between 10-20%, which will be due on the sale of the shares and applied to the gain in value of shares from the point they were awarded. In the case of share options, capital gains will be payable on any gain in value over the price paid on exercise.
The main HMRC-approved schemes are:
Enterprise Management Incentive (EMI) Share Options
The most popular type of share scheme for private companies is the Enterprise Management Incentive (EMI) scheme, which is aimed at smaller, entrepreneurial companies with fewer than 250 full-time staff. It is considered one of the most flexible and generous of the UK’s tax-advantaged share plan regimes. Companies with assets of £30 million or less can grant options up to a value of £250,000 in a three year period. It is relatively easy to implement, does not have to be offered to all employees and attracts favourable tax treatment, meaning it will be particularly appealing to higher rate and additional rate taxpayers. However, employees can only receive EMI options and therefore the tax advantages associated with them if they work for at least 25 hours per week (or if less than that, 75% of their overall paid working time). In addition, certain trades do not qualify, for example companies in property development, leasing and financial activities do not qualify for EMI.
If EMI options are granted, there will normally be no income tax charge or National Insurance contributions (NICs) due when the options are exercised, however long the options have been held. When the shares are sold, the employee will have to pay capital gains tax on his gain. Business asset disposal relief, which charges capital gains tax rate at a rate of 10% on the first £1 million gains (lifetime limit) may be available subject to certain conditions.
Company Share Option Plans (CSOPs)
Under a company share option plan (CSOP), employees are granted an option to acquire shares with an exercise price at or above the market value at the date of grant. The maximum value of shares under a CSOP plan for any one employee is £30,000, which means that such options are not sufficiently motivating for senior executives.
In one of the few mini-budget changes announced on 23 September 2022 to have survived, the Government stated that the limits on the value of options that can be granted under CSOP are to be increased significantly. From April 2023, qualifying companies will be able to issue up to £60,000 of CSOP options to employees. The rules restricting the share classes which may be used by companies granting options under CSOP are also to be relaxed, which will bring the rules closer to those for the EMI Scheme. Currently, only one class of shares may be in issue if share options are to qualify for tax advantages under the CSOP rules.
As with EMI, the company has discretion to select which employees can participate and may impose performance conditions that must be met before the option can be exercised.
So long as the statutory conditions are met, there is no income tax and NICs on the exercise of a CSOP option, but capital gains tax will be payable on the sale of the option shares.
Save As You Earn, Sharesave, Or Savings-Related Share Option Schemes (SAYE)
Under an SAYE option scheme, the employee is granted an option to acquire shares in the company at a discount of up to 20 % of the market value of the shares at the date of grant. The employee must save a certain amount of their salary each month for a specified period and can then use the proceeds of their savings to buy shares. If the employee does not want to buy shares, they can choose to have their savings (and, depending on when the option was granted, a tax-free bonus) paid out in cash.
Unlike EMIs and CSOPs, SAYE option schemes are all-employee schemes, so participation has to be offered to all qualifying employees. If the statutory conditions are met, there is no income tax or NICs on the exercise of an SAYE option, but capital gains tax may be payable on the sale of the option.
Share Incentive Plans (SIPs)
Share incentive plans (SIPs) enable employees to acquire shares rather than share options in the company. As with SAYE, this is also an all-employee scheme, so participation has to be offered to all qualifying employees. Furthermore, SIPs are expensive to run as they have to comply with relatively detailed HMRC requirements.
The company can offer employees free shares, partnership shares - which employees buy out of their pre-tax income - and up to two free matching shares for each partnership share bought. Dividends on the shares can also be reinvested in the SIP in further shares, known as dividend shares. There are holding periods for each type of SIP shares, and if these are met, there is no income tax or NICs payable when shares are withdrawn from the SIP.
Disadvantages Of Employee Share Schemes
While there are clearly benefits of setting up an employee share scheme for both employers and employees, they can be complex to set up and administer and more expensive than other incentive schemes.
Share prices are volatile and unpredictable, and this unpredictability may cause difficulties for staff who own employee share schemes shares when the economy takes a downturn. A failing share price may also damage employee morale, retention and motivation. However, given that most schemes offer employees shares on very favourable financial terms, either through gifting shares or offering them at a significant discount, employees’ financial loss should be minimal.
Another thing to bear in mind is that with some employee share option schemes, employees will have to wait some years before gaining any benefit. They may not be willing to risk missing future employment opportunities and if they leave before the required qualifying period, they may have to repay any income tax or national insurance relief provided by the scheme.
Non Tax-Advantaged Schemes
It is also possible to set up share ownership schemes that don’t offer tax incentives but are still advantageous to employees. In such circumstances, income tax and NIC will be payable on the exercise of options as well as capital gains tax on the sale of the option shares.
Nevertheless, non tax-advantaged share option schemes generally have greater flexibility in the terms that can apply to the options and shares and are also available to most public and private companies. For example, options can be granted to non-executive directors, consultants and international employees and others who are not eligible for HMRC-approved options. There is also no limit on the number of value of options that can be granted. Such schemes can also be used as top-ups to HMRC-approved schemes.
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