In times where cash is tight clever employers will look for alternative ways to attract and retain their key people which do not cost them significant amounts of cash. One such route is to consider bringing your key people into the ownership of the business.
The first reaction for many owner-managers is a look of horror – “why would I give away a part of my business to someone – it’s my baby and I have grown it from nothing?” It’s a fair point but maybe a better question might be “if I gave Janet or John 10% of my business, would their extra effort mean that I would have 90% of a bigger pie?” That is the fundamental equation that any business owner should consider – do I think these more highly motivated and incentivised employees will drive my business so much further forward that my 90% will be worth more than 100% of the business if they weren’t so motivated or, worst still, they got a better offer from somewhere else?
Of course there are no certainties so in the end it becomes a judgement call – but in a tight labour market this extra opportunity for those employees might be the difference between keeping them or losing them…
As the name suggests, a share scheme is a way of allowing your key employee(s) to share in the ownership of the company in some way. The aim might be to allow them to receive dividends as a bit of an extra income boost, or it may be to allow them to share in the proceeds of a sale when the time eventually arrives. There are many different alternatives (more details below) – which is the “right” one will very much depend on what the business owner is trying to achieve – and what will actually motivate the employee(s) in question…
Whatever share scheme structure you adopt the key to success (aside from getting the right advice in setting it up) is communicating with the employees who will participate. Too often we see share schemes of one flavour or another implemented, but the employees concerned simply do not understand what it means to them. When employees don’t understand then there is a real risk they will not place any value on their participation in the scheme, meaning in turn that it is highly unlikely to have the effect the employer is looking for. The whole process then risks being a waste of time and money…
Ensuring that you communicate effectively to the participants exactly what is in in for them means that they are far more likely to understand and place value on the opportunity you are giving them. We would generally suggest leaning on your professional advisers in this situation so that they can meet with the participants, explain the benefits and answer any questions. This return on this small extra investment can be extremely significant.
Most share schemes tend to be aimed at specific individuals who are key to the business but there are a couple of alternatives which are intended to be available to the whole of the employee base. A Save as You Earn scheme allows employees to access tax benefits by saving an amount of money each month to purchase shares in their employing company. A Share Incentive Plan on the other hand allows an employer to give free shares to their employees, or allow employees to “buy” shares out of their pre-tax pay.
The reality is that both schemes are rather complex and involve a lot of administration, and so are usually the preserve of larger employers. However, we have seen these schemes successfully implemented in smaller business where the schemes align with the wishes of the business owner.
Turning to look at more targeted schemes, these can be roughly split into those which carry statutory tax advantages and those that do not. For SMEs the most common tax advantaged scheme is the Enterprise Management Incentive or EMI scheme. This is a share option scheme – so the employee does not get shares, they instead get a right to buy those shares in the future for a fixed price (known as exercising the option).
The big benefit for an EMI scheme is that the exercise price for the option (the price at which the shares can be bought) can be set at the market value of the shares at the time of issue of the options (often with a significant discount to the full price because of minority holdings etc). Generally, if this were done the employee would pay income tax when they buy the shares on the difference between the price they pay and the value of the shares at that time. Under an EMI scheme however there is no income tax at that point – instead the shares are subject to capital gains tax when they are sold.
The employing company can also get a tax deduction for the difference between the amount paid for the shares and the value at the time they are acquired – which can amount to a substantial sum.
There are a lot of qualifying conditions to meet – the scheme is aimed only at smaller companies and generally at those who spend pretty much all of their working time working for the employer in question. It also does not apply to some “lower risk” industries (apparently accountancy firms are low risk and so can’t qualify for EMI schemes!)
EMIs are a great option (pardon the pun) for those looking to provide equity awards to employees in a tax efficient way. However because of the qualifying conditions not all businesses can implement an EMI. The bigger brother of the EMI scheme is the Company Share Ownership Plan. This is an option scheme as well and there are fewer restrictions on the size and type of company that can use them.
The conditions around the options however are more complex, and the value that can be given is more restrictive, so these schemes are more rarely implemented by SMEs and even then only when the EMI can’t be used. Nevertheless, they do give tax advantages and should not be ruled out as an alternative in the right circumstances.
As the name suggests, these are share schemes that do not carry specific tax advantages set out in legislation. That is not to say however that at least some of the these schemes cannot be set up in a tax efficient way.
At its most basis level a non-tax advantaged share scheme can simply be giving free shares to an employee. The employee will generally be subject to income tax on the difference between the price they pay (if any) and the value of the shares they are given. In most SME situations the amount they are taxed on is not subject to PAYE and NIC, but these rules can be complex and it is important to be sure. There can also be additional complications if the shares have restrictions on them (for example limiting the ability to sell the shares) – the “restricted securities” rules carry some big traps for the unwary so proper advice is essential.
Some employers will grant their employees options over shares which do not qualify for either the EMI or CSOP rules. Often but not always these will be granted by an overseas employer where the scheme rules do not meet the CSOP requirements. Where this is the case the employee pays income tax when they exercise the options, again on the difference between the price paid and the value of the share at the time. The same rules apply re PAYE and NICs, and again care is needed not to fall foul of the restricted securities rules.+
The most common form of non-tax advantaged share schemes for SMEs is the growth share. Very broadly a growth share allows the holder access to capital value in the shares only once the value of the company exceeds a fixed (“hurdle”) amount. So for example an employee may have growth shares giving them 10% of the value of the company when that exceeds £5 million. If the company value stays below £5 million then the employee has no right to value – but once it exceeds that figure their value kicks in and they get 10% of any value over that amount.
The key in growth shares is to set the hurdle amount at a figure that means the shares have minimal value at the time they are issued – to avoid an income tax charge arising on the employee. Setting the hurdle at the current company value is important as increasingly HMRC will argue (probably fairly) that there has to be some value whether it be “hope” value in respect of future growth, or the expectation of dividends.
At the same time if the hurdle is too far above the current value of the company then the risk is that this becomes a disincentive to the employee who sees little prospect of their shares ever starting to be worth something… The hurdle amount can be a fine judgement call so again it is important to get the right advice to avoid tears later…
When set up properly growth shares can be a powerful tool to protect the value created by the owners to date but incentivising the employee because their interests are now directly aligned with those of the business owner…
One final practical word – most employee share schemes carry reporting requirements which although not especially onerous can be overlooked or ignored. In some cases the risk is that the company receives a fine for failing to meet its obligations, but in others (specifically the EMI scheme) the tax advantages for the employee and employer can depend on making the correct notifications to HMRC. It would be a real shame to fall at the final hurdle having done all of the hard work!
If you are an employer looking for alternative ways to attract and retain employees that won’t cost you a significant amount of cash then get in touch. Our team at ETC Tax will be able to guide you as to what is best for your business wiht regards to employee share schemes.
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