Attracting and retaining top talent is a critical challenge for businesses today. Employee share schemes (ESS) offer a powerful solution, aligning the interests of your team with the success of your company. With research consistently demonstrating a positive impact on company performance and employee productivity, ESS can be a game-changer for businesses looking to incentivise their workforce and foster a culture of shared enterprise.
This article will guide you through the diverse landscape of Employee Share Schemes, explaining the various types available, from popular EMI share options to phantom share options, and detailing the benefits for both employers and employees. We'll explore why setting up an ESS can be a strategic move for your company, how these schemes can transform company culture, and the tax implications of each.
If you're considering implementing an employee share scheme to motivate your team and drive growth, or if you need expert advice on structuring the right scheme for your business, our specialist employee share scheme solicitors are here to help.
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Why set up a scheme?
There are a number of very good reasons why you might consider setting up an ESS as part of your overall benefits package:
- ESS are a popular and attractive addition to a benefits package when recruiting, especially where cash is tight in growing companies – employees can be offered ESS as an alternative to salary
- According to research, ESS have a positive effect on company performance overall, as well as productivity per worker
- Employees who own shares feel more connected to the business, their job satisfaction improves, and they become focused on the company’s success as an objective
- Employees feel more loyal, and this improves retention and morale
- ESS can help transform company culture, creating an atmosphere of shared enterprise and trust by aligning the interests of employees with those of the shareholders
- Employees develop a longer-term view on company performance and shift their perspective to a holistic one involving the whole company team. Absenteeism can also decrease
- ESS can be a tax efficient way to reward employees
- Read our article on how to set up and operate an employee share scheme for more information.
- Different types of employee share ownership schemes
Why is an ESS good for the company?
Setting up an ESS can be a powerful way to ensure the success of the business, particularly for start-up and growing companies. Employees that own shares are highly motivated to work hard to ensure the company succeeds, and this can be a valuable incentive in high-growth businesses where long hours are common.
What are the benefits for employees?
ESS are an effective way to reward employees. They can form part of the remuneration package and can be structured to provide tax benefits. As shares increase in value, workers can benefit from that uplift. If ESS are structured appropriately, employees can also receive tax advantages.
Are there any disadvantages to an ESS?
Effective ESS need to be properly planned and structured and there is some ongoing administration and compliance, so there is some expense for the company. However, given the incentives and the alignment with shareholders that can be provided and the fact that most ESS offer employees share rights on very favourable financial terms, the worst-case scenario for employees is that they might have given up cash pay for equity which does not ultimately pay out .
Comparing the different schemes
The general tax principle is that employees will pay employment income tax, and often national insurance contributions if they acquire shares (either by direct subscription or through the exercise of a share option) by reference to the value of the shares they acquire less the amount (if any) they pay for them. However, HMRC operates a number of tax advantaged arrangements that have been supported by successive governments. The following section looks first at the HMRC tax advantaged arrangements and then at non tax-advantaged arrangements.
HMRC Tax Advantaged Schemes
Enterprise management incentives (EMI) options
EMI options are designed for use by start-up or growing, higher-risk trading companies and permit option awards to be made in respect of shares with a tax value of up to £250,000 per individual and £3m overall, measured at the time the awards are made.
A number of statutory requirements must be met in order for a company to qualify to grant EMI options. In particular, a company must be a trading company:
- With gross assets of no more than £30 million;
- With fewer than the equivalent of 250 full-time employees;
- Which is 'independent' (not controlled by another company); and
- Which does not carry on an 'excluded activity' (companies carrying out certain trading activities do not qualify for EMI).
Where all the requirements are met, the exercise of an EMI option benefits from relief from income tax/NICs and the sale of the shares acquired through option exercise is treated as a capital gain. In addition, shares acquired on the exercise of EMI options may qualify for business asset disposal (previously entrepreneurs’) relief, irrespective of the size of the underlying shareholding.
Company share option plans (CSOPs)
A CSOP allows employees to be granted options to acquire shares in their employer, or employer's parent company. If statutory conditions are met, any gain on the exercise of options will be free from income tax and NICs. The sale of shares acquired through the exercise of qualifying CSOP options will be treated as a capital gain.
CSOP options can be granted over shares with a total market value of up to £60,000, measured by reference to the tax value of the shares at the date(s) of a grant of the option(s), provided the company, employees and the plan rules meet certain requirements. Subject to certain 'good leaver' exemptions, options must be held for at least 3 years from the date of grant to qualify for capital gains treatment.
Share incentive plans (SIP)
A SIP allows employees to acquire shares in their employer, or employer's parent company, which are held in a special type of employee benefit trust. Where all the relevant conditions are met, and the shares are held in the SIP trust for between three and five years (depending on the type of award), no income tax arises on the shares, and no capital gain arises while the shares are held in the SIP trust.
Under a SIP, employees can be awarded free shares (up to £3,600 per year), partnership shares (up to £1,800 per year), matching shares (up to £3,600 per year) and dividend shares (no financial cap).
The company, the employees and the SIP trust must meet specific statutory requirements to qualify for a SIP and participation must be offered to all employees.
Save as you earn share option schemes (SAYE)
A SAYE Plan allows employees to be granted options to acquire shares in their employer, or employer's parent company under option arrangements which have two elements:
- A savings arrangement; and
- A share option.
The employee can choose whether to use the proceeds of the savings arrangement to fund the exercise price of the option. The grant of the option is conditional on the employee entering into an HMRC-certified savings arrangement. This will require the employee to save between £5 and £500 per month for three or five years, generally by deduction from pay (after tax). At the end of the savings period, the accumulated savings can be withdrawn, or used to fund the exercise price of the option.
SAYE options can be granted with an exercise price set at a 20% discount to the tax value of the shares under option as at the date of grant. Participation must be offered to all employees.
Non-HMRC tax-advantaged schemes with tax advantages
As well as the schemes discussed above, all of which provide some benefits in terms of tax treatment where qualifying conditions are met, it’s also possible to set up share ownership schemes for employees that can still offer tax advantages. The following are share (share right) acquisition arrangements where the company/shareholders can protect themselves in respect of voting rights, dividend rights and good leaver/bad leaver requirements as appropriate.
Share Subscription Arrangements
Where the value of a company’s shares is low, employees can subscribe for shares at market value and any increase in value should be treated as a capital gain.
Growth/Hurdle Share Arrangements
If a company’s shares have some value, a growth shares arrangement can be used to manage the acquisition cost of the shares, Broadly, this is done by creating a new class of shares that has no value until a pre-determined hurdle is reached, which should reduce the value of the shares at the time of acquisition. Employees can then subscribe for the growth/hurdle shares at market value and any increase in value should be treated as a capital gain.
Joint Share Ownership Arrangements
These are trust based arrangements where (broadly) the trustee owns the current value of the shares and employees acquire a share interest which entitles them to any increase in value. The employees pay market value for their share interest and any increase in value should be treated as a capital gain.
Non-tax advantaged schemes without tax advantages
While certain non-tax advantaged schemes don’t offer tax benefits, they can still provide valuable incentives and be advantageous to employees. Here are some examples of the most common non-tax-advantaged schemes:
Non-Tax Advantaged ('Unapproved') Share Options
These are rights to acquire shares in the future at an option exercise price set at the date of grant. The options are subject to employment income tax and NICs on exercise by reference to the difference between the value of the shares at the date of exercise less the option exercise price paid to acquire them.
Phantom Share Options
These are rights to a cash payment in the future which is referrable to the value of an underlying asset (often a company’s shares). The cash payment on exercise of phantom options is subject to employment income tax and NICs on exercise by reference to the amount paid.
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