Share Schemes

The aim of employee shares schemes is to try and incentivise employees to work harder and more effectively in their employer's cause by providing them with an equity stake in the business. The majority of shares schemes involve the use of share options that the employee will be able to exercise at some point in the future and benefit from the growth in the value of the shares without having to lay out any cash at the start of the option period.

Remember that tax rules are subject to change. The FSA does not regulate employee share schemes or tax advice.

Effectiveness of share option schemes

In considering the effectiveness of share schemes, both employers and employees need to take into account the following main factors:

· The value of the shares in the company may rise or fall independently of the efforts of the employees – even senior ones. Moreover, general stock market movements can outweigh the particular qualities of the company.

· Share movements may take some time to reflect the real advances that a company has made, and this factor, combined with the general vagaries of equity investment can mean that the time it takes for shares to provide a good return may well be longer than the timescale available to the employee under the share scheme – especially if the employment is terminated prematurely and the options lapse as a result.

· There may not be a very ready market for the shares. With private company shares, this is likely to be the main limitation on their value as an incentive. Unless arrangements have been made to create a special market in the shares among other employees or shareholders, the shares will probably only have a value if the company is sold or floats on the stock market.

· Employee shares issued by the company are not cost free for the other shareholders. Every extra share that is issued will dilute the value of the existing owners' shares and will have an adverse impact on both their potential capital gains and future dividend income.

· The tax position of the share scheme is very important and can make a very considerable difference to its attractiveness.

Unapproved employee share schemes

Share schemes can be approved by HMRC or they may be unapproved. Approved schemes have some tax advantages but they have to meet certain stringent conditions in order to qualify. Unapproved schemes may still be worthwhile, but they suffer from a generally less advantageous tax position.

The main HMRC approved schemes

The tax pitfalls of unapproved scheme can largely be avoided by setting up an approved scheme. The main approved schemes are as follows:

The share incentive plan

The share incentive plan, which operates through a trust, allows employers to provide employees with a limited amount of free shares without a tax liability. It is therefore not a share option plan.

· The company can give employees shares worth up to £3,000 a year. To some extent the value of shares distributed in this way can be related to each employee's performance.

· Employees can also buy shares out of their gross earnings before income tax and national insurance – so, in effect, they benefit from tax relief on the share purchase. The maximum they can buy in this way is up to 10% of their salary with a cap of £1,500.

· The employer can give employees up to two shares for every share the employee buys, ie up to a further £3,000 a year or 10% of salary.

· Employees can reinvest up to £1,500 of dividends on shares under the plan without paying higher rate tax on them.

Tax advantages

There is no tax charge when the shares are ‘appropriated' to the employee in the trust. Shares are free of income tax and NICs if they are not withdrawn for at least five years and certain shares may be withdrawn earlier. While the shares are held within the plan, any growth is tax free; after they are withdrawn, they may be subject to capital gains tax.

Enterprise management incentive (EMI) option scheme

The EMI scheme allows companies to grant qualifying options to employees. An EMI scheme does not need formal HMRC approval and is more flexible that an approved company share option scheme.

Any number of employees can participate in the EMI scheme. The options do not have to be offered to all employees and the terms can be individually tailored to the needs and circumstances of the individuals.

The main condition is that no employee must have unexercised options worth more than £100,000 based on the market value of the shares at the time the options have been granted. The total value of these unexercised options for all employees must not exceed £3 million.

Tax benefits of EMI

The tax benefits of the EMI are significant. When the options are granted there is not tax or NIC. Any gain on the shares between the base cost – the cost of the option – is subject to CGT, with the business taper relief starting to count from the date the options were granted, rather than the date of when they are exercised. So, taper relief could apply to the exercise of options that are followed instantly by the sale the shares, which would not be the case under other schemes.

Approved company share option schemes

The approved profit sharing share option scheme was the main type of scheme used until 1996 when a £30,000 limit was placed on the value of the shares that can be placed under option for any individual in the scheme. It is still used by companies that cannot qualify for the EMI scheme.

Approved savings-related share option schemes

The approved savings-related share option scheme allows employees to be granted options to acquire shares linked to a Save As You Earn (SAYE) contract of between £5 and £250 a month whose proceeds are tax free. They are allowed to exercise the options when they have accumulated enough funds in the contract.

How we can help

With variety of schemes available, it is important to seek competent professional advice to avoid the real pitfalls for employer and employees. We can introduce you to an expert adviser who can help you choose the most appropriate schemes to suit your business.

We can advise on tax-efficient remuneration strategies, focusing especially on pension, life and health insurance solutions.