Tops Tips For Employee Share Incentivisation

Employee Share Incentivisation

In the current climate, the recruitment and retention of staff have become more vital than ever for the growth and long-term success of a business by employee share incentivisation.

Whilst the retention and engagement of all staff are critical for the long-term success of a business, most businesses would identify a select number of high-performing, senior employees as critical in terms of the future success of a business. It is vital that these employees are rewarded appropriately and also provided with further incentives to grow the business.

There are several tax-efficient options that most owner-managed and family businesses can use to achieve the above, with share incentivisation increasing in popularity in recent times. We have set out some of the most common share incentivisation routes below.

Enterprise Management Incentives (EMI)

The EMI share option scheme is considered to be the most popular share option route within the SME and owner-managed sector.  It allows employers to reward employees in a tax-efficient manner without causing a significant drain on the cash flow of the business.

The primary benefit of the EMI scheme is that options over shares can be granted to key members of staff at today’s value, which can be agreed with HMRC in advance. Provided the exercise price (i.e. the price which the employee pays for the shares upon exercising the options) are at least equal to the market value of those shares at the date of grant, there are no income tax or NIC implications for the employee.

Assuming the company grows in value and the employee stays with the company, the growth in value can usually be ‘protected’ from an employment income tax charge and would instead only be subject to capital gains, with the capital gains tax arising only when the employee subsequently disposes of their shares.

An EMI option can therefore be exercised at a point in the future, which is usually set as:

1. When a sale of the company occurs; or

2. When certain performance or other criteria are met.

The first step for the company is to agree a valuation with HMRC prior to the grant of share options. As the shares are usually in respect of a minority shareholding in the company, HMRC generally accept that those shares are heavily discounted (as much as up to 80% in some cases). There are numerous qualifying criteria and reporting requirements which need to be met and it is very important that specialist tax and legal advice is sought prior to implementation.

Employee Shareholder Shares

A company can give new shares to employees in exchange for the employee giving up certain employment rights. These employee shareholder shares will be exempt from capital gains tax upon sale on up to £100,000 of gain. The ESS is considered a useful way of attracting and retaining talented staff in start-up ventures.

Growth Shares

Also known as flowering or freezer shares, such shares seek to ‘freeze’ the existing value of the company and then issue a new class of share which only have rights to the future growth of the company.

As an initial step, the rights attaching to the existing shares are altered so that all of the value of the company at that stage is reflected in the value of those shares. A new class of growth shares is then allotted, and the rights attaching to these provide that the shares are only entitled to participate in the proceeds of the sale of the company above the value of the company now locked into the value of the existing shares.

The allotment of growth shares gives employees the legal benefit of share ownership from day one. It is important that market value is paid for the shares and that they are carefully implemented to ensure that no unexpected tax issues arise. Careful drafting of the company’s articles is called for, and the difference between intrinsic and extrinsic rights attached to the growth shares must be recognised.

Company Share Option Plan (CSOP)

The CSOP is a tax-advantaged discretionary option plan under which a company can grant options to grant options over shares to employees and directors over shares. The maximum amount of options an individual can receive is £30,000 as of the date of the grant.

As long as the exercise of the options takes place three or more years after grant, then the acquisition of the shares will be free of income tax and National Insurance contributions (NICs).

Share Incentive Plans

A Share Incentive Plan (“SIP”) allows companies to offer flexible terms to their employees. All employees must be invited to participate, subject to a qualifying service period set by the company.

There are several ways SIP shares can be offered to employees:

• Accept an offer of shares with a market value of up to £3,600 per tax year (referred to as “Free Shares”).
• Purchase shares in the company using up to £1,800 of earnings per tax year (known as “Partnership Shares”); and/or
• An appropriation of shares on the basis of up to two free shares for every one partnership share acquired out of gross salary (“Matching Shares”).

Employee Ownership Trust ("EOT")

EOTs were introduced in 2014 after a government consultation on incentives available to employees in privately-owned companies. An EOT is a vehicle that holds shares in a company on trust for the benefit of the employees, resulting in the employees having an indirect ownership in the company. Provided certain qualifying conditions are met, it is possible for the owners of a company to sell their shares tax-free to an EOT.

Some key facts and advantages of EOTs are as follows:

• The trust holds all or majority of company shares on behalf of all employees;
• The EOT must operate for the benefit of all employees, with some exclusions;
• The seller sells the business at market value. Often this involves excess cash which has been generated in the business plus an element of deferred consideration. Most tax-efficient exit routes are available to business owners as they can potentially sell to an EOT without a CGT charge. Annual income tax-free bonuses are available for employees. Owners can step back from the business over time and at their own pace.

Key Points

1. Whilst the above plans work well in practice and can lead to great results, it is important that specialist advice is sought and key criteria and compliance requirements are followed, as failing to do so can lead to unexpected tax costs for the company and option holders.

There are specific procedural requirements which must be followed. For example, in respect of an EMI scheme:

• We should first establish whether the company itself qualifies for the scheme;
• Submit a valuation application to HMRC;
• The valuation is valid for 90 days and the options have to be granted during this window.
• Notification of the options must take place within 92 days following grant.
• Annual returns must be filed between 6 April and 6 July following the tax year.

2. It is also crucial that specialist legal advice is sought to implement the above plans. Lawyers can guide through a range of areas, including vesting terms, ensuring that plan rules are drafted appropriately and option agreements are tailored to the specific requirements of the company and option holders. 

3. Ensure a robust valuation exercise is undertaken, and our recommendation would be, where possible, to agree a value with HMRC that is low as possible.

4. There are annual reporting requirements for all options issued to employees. In particular, for employee share incentivisation, there is a further requirement that a notification must be made within 92 days of grant. Failure to do so could make the scheme void, which can lead to unexpected tax costs.

If you have any queries about this article, employee share incentivisation or other tax matters in general, then please get in touch