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Guide to structuring employee ownership

Although employee ownership schemes have been around for a while, giving your hard-working staff a share in the business they are helping to build is becoming more common. One of the reasons is that employee-owned businesses have been shown to be more productive, faster growing and more profitable than comparative businesses that don’t offer such incentives to their staff.

Employee ownership schemes are relatively easy to set up and maintain, and many carry tax advantages that make them even more attractive. This guide will introduce you to the benefits of employee share ownership, and help you navigate the task of setting one up.

What are the different types of share ownership scheme?

There are various ways that employees can become owners of shares in your company. The method you choose depends on multiple factors, for example the stage your company is at (start up or established business), whether your company is small private business or listed on a stock exchange, the type and seniority of employees who will hold shares, and whether you are looking to obtain tax advantages in connection with the scheme.

Outright ownership of shares or options

One of the simplest ways to award shares to your employees is to give them shares or options to buy shares, or alternatively allow them to buy shares.

If you choose to give shares to your employees, unless you do this as part of a tax-advantaged scheme such as a Share Incentive Plan (SIP), your employees will pay income tax and potentially National Insurance Contributions (NICs) on the shares.

If your company is private and relatively early in its life, because the shares probably won’t be worth much, the tax payable will be small so this won’t be a major consideration. But setting up a SIP can be more advantageous if your shares are valuable.

If you sell shares to employees at market value, this won’t have any immediate tax consequences for the employee, although they may pay capital gains tax (CGT) in the future if the shares increase in value. The disadvantage in selling shares to staff is that they need to raise the purchase price themselves, although you can give them the option to pay for the shares in instalments.

In the case of a grant of shares options, no tax is payable when the option is granted. However, if the shares are worth more than the option price when it is exercised, then tax and potentially NICs are payable on the difference between the option price and the actual price paid. There are various schemes such as Save As You Earn Schemes (SAYE), Company Share Option Plans (CSOPs) and Enterprise Management Incentive option schemes (EMI) that can provide certain relief from income tax and NICs on options.

Trusts

Another way of giving employees shares in your business is to set up a trust that will hold shares on behalf of employees (an Employee Benefit Trust). Certain schemes are tax advantaged provided that the shares remain held in the trust for a certain period of time.

If you own a commercial trading company, one way to sell your business is to transfer shares to a trust known as an Employee Ownership Trust or EOT. Provided the trust meets certain conditions, there are tax advantages associated with this kind of sale. A trust will be set up to which the existing shareholders will sell their shares. The share price will be determined by a company valuation. The purchase price will not be paid immediately but over time and out of the company’s profits.

The different types of tax-advantaged scheme for employee share ownership

 How they workTax advantagesType of employeeMain conditions
Share Incentive Plans (SIP)Employees are given or can buy a certain number of shares in their employer and these are held in a trust.  No tax or NIC on shares that are bought by or given to employees.   No CGT on any increase in value.  All employees must be given the chance to participate.Shares must be held for at least five years.   Certain ceilings apply in terms of the value of shares awarded or bought each year.
Save As You Earn (SAYE)Employees are given an option to buy shares after a certain period and pay for them out of their post-tax income over time.  No income tax or NICs on any increase in value when share options are exercised.Must be offered to all employees.Option period must be at least three years.   Share price can be up to 20% lower than the market value when the option is exercised.
Enterprise Management Incentive scheme (EMI)Managers of small companies are given options to buy shares at a future date.No income tax due on the grant of the option. CGT is payable on disposal of the shares.ManagersMaximum value of options to an employee is £250,000 in any three-year period.   Total limit of £3,000,000.
Company Share Option Plan (CSOP)Certain or all employees are given options.  No income tax or NICs on any gain in value when options are exercised. CGT will be paid on the gain.Certain class of employees or all employees.Each employee can hold a maximum of £30,000   Options must be held for at least three years.    
Employee Ownership Trust (EOT)Employees buy shares in their employing company via a trust.No income tax, inheritance tax or CGT is due on the sale.   Employees can receive a tax-free bonus of up to £3,600 each year.All eligible employees.For two years after sale to the trust strict conditions apply.

Things to consider when setting up an employee ownership scheme

If you are thinking of setting up an employee incentive scheme, you’ll need to consult an expert corporate lawyer, as your company’s constitution (Articles of Association) will need to be changed to accommodate the scheme. You’ll also need to put in place a communications plan to let your staff know what they need to do if they want to take up options to buy shares or buy shares.

If the scheme will be tax-advantaged, you may need to ask HMRC to qualify your plan, or at a minimum you’ll need to register the plan with them and provide them with information about the plan each year.

You’ll also need to think carefully about the kind of scheme you want to set up, depending on the nature of your company, and the views of existing shareholders, given that their existing shareholdings may be diluted by the employee scheme. You’ll also need to think about how your employees will fund any purchase, and if this isn’t possible, grant options instead.

If you will be setting up a trust, you should select the trustees carefully, ideally an independent and suitably qualified person.

You can set up an employee share ownership scheme at the start of your business’s life, or when you have been operating for a number of years. It’s becoming increasingly common for start-ups to set aside a pool of shares for employees at the outset, as this is seen as a great way to incentivise staff, and because the value of the shares is likely to be low, it’s not only more affordable for employees but the tax implications are minimised.

If you are thinking about selling your company to your employees, consider setting up an employee benefit trust. If you want to go down this route, you’ll need to consider how much of your company to sell to your staff, how they’ll finance the purchase, and the views of your existing shareholders. If you want to take advantage of an EOT, there are certain strict conditions that must be met after the sale.

Employee ownership scheme rules in detail

Share Incentive Plans (SIPs)

  • You must set up a trust to hold the shares.
  • Employees can be given shares without paying income tax or NICs on the value of the shares.
  • You can give employees matching shares without their paying income tax or NICs (maximum of two for every one bought).
  • Employees can buy partnership shares out of their gross pay so no income tax or NICs are payable.
  • Dividends payable on shares can be given as additional shares.
  • No CGT in growth in value of shares.
  • Partnership shares are allocated once each year along with any matching shares. Free shares can be given at any time.
  • All employees must be invited to participate although you can set a qualifying period.
  • The shares must normally be held in trust for five years.
  • The company won’t pay employer’s NICs on the employee’s pay they use to buy shares.
  • The cost to the company of providing free or matching shares is deductible against corporation tax.
  • You can link the award of free or matching shares to employee performance.
  • You can provide that the shares will be forfeited if the employee leaves.
  • There are annual limits of £1,800 for partnership shares, and £3,600 for matching shares.

Save as you earn schemes (SAYE)

  • Employees are given options to buy shares without paying income tax or NICs on any gains.
  • The option has a set exercise price. The option can be at a discount of up to 20% of the market price when the option is exercised.
  • The employees must set aside part of their income each month to pay for the shares over a minimum three-year period.
  • The employee will pay CGT on the gains.
  • Employees don’t have to exercise the option to buy shares and can keep their funds if they don’t do so.
  • All employees must be awarded options although you can set a qualifying period.
  • There is a maximum monthly amount employees can save, and the savings period can be three or five years.

Company share option plans (CSOPs)

  • Employees can obtain share options without having to pay income tax or NICs on any gains provided they exercise the option between three and ten years after the grant of the option.
  • CGT will be payable on any gain when the employee sells the shares.
  • There’s a limit of £30,000 per employee in terms of the value of shares over which they are granted options.
  • You don’t need to offer CSOPS to all employees.
  • If an employee leaves before the three-year period is up, they’ll pay income tax and NICs unless they leave because of redundancy or illness for example.
  • Any gains by employees can be treated as an expense of the company for corporation tax.

Enterprise management incentive schemes (EMIs)

  • Designed to be used by SMEs.
  • Certain types of businesses are excluded, and the company must be UK based and independent.
  • The employee must broadly be full time, and not hold more than 30% of your company’s shares.
  • Options can’t be granted over more than £3,000,000 of shares, with a limit per employee of £250,000.
  • Provided the option exercise price is the same as the market price when the option is granted, no income tax or NICs is payable on any gain.
  • If the option exercise price is less than market value on the date of grant, income tax and possibly NICs will be payable on exercise on the amount of the difference.
  • CGT is due on any gains, but entrepreneurs’ relief may be available.
  • Certain events may mean that income tax is payable on gains, for example if the employee no longer works full-time, or the company changes its type of business.
  • Leavers can be asked to forfeit their options.
  • You can choose which employees to benefit from the scheme.
  • Gains by employees can be treated as an expense for corporation tax purposes.

Employee Benefit Trusts

  • You can set up a trust to hold shares on behalf of your employees.
  • You can potentially raise finance to buy the shares.
  • The trustees will decide who can buy and sell shares.
  • Income of the trust is held by the trust.
  • You must decide what the trust’s purpose will be, for example, will the shares continue to be held in trust, or can their ownership be passed to individual employees at a certain point in time?
  • The trust will pay CGT on any gains it makes if it sells shares. It will also pay income tax on any dividends and potentially inheritance tax.
  • You can set up an employee benefit trust either by gifting shares from the company, obtaining a loan from the company, or borrowing money.
  • Certain employee benefit trusts known as Employee Ownership Trusts (EOTs) are associated with tax benefits for employees.

Employee Ownership Trusts

  • With an EOT, selling shareholders won’t pay CGT on the sale of shares to a trust, and the EOT company can pay income tax-free bonuses to employees.
  • The company must be a trading company.
  • All employees must benefit equally.
  • The EOT must not hold a controlling interest in the company before the transfer and must hold a controlling interest afterwards.
  • There is a maximum limit of £3,600 for the tax-free bonuses.
  • The trust will have to pay stamp duty on share purchases and employees pay NICs on bonuses.

What next?

Need advice on setting up employee ownership schemes? Get in touch with our corporate team on 0800 689 1700, email us at enquiries@hjsolicitors.co.uk or fill out the short form below with your enquiry.

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