Employee share schemes are a great way to incentivise employees, and can ultimately help a company retain key individuals in the long term.
An issue many established companies face with getting shares under the ownership of employees, is that where the shares have a significant market value attributable to them, this can lead to employees suffering potentially large income tax liabilities.
Given the general economic outlook at the present time, and the decline in business performance that many companies are facing due to COVID-19, now could be the perfect time to take advantage of potentially lower share valuations which would ultimately provide greater financial benefit to employees and in a tax efficient way.
There are various routes to bringing in employee shareholders. These include;
1. An Enterprise Management Incentive (EMI) scheme.
The majority of small and medium sized entities can benefit from an EMI, with the exception of some entities undertaking ‘excluded activities’.
EMIs operate through the use of share options, rather than transferring shares to employees directly. Option holders may be permitted to exercise options after a short period of say, 6 months, or alternatively, in the event of an exit such as the takeover of the company by a third party.
An EMI scheme enables a share valuation to be agreed with HMRC upfront, and provided the employee pays the original option grant date market value for the shares at the date of exercise, no income tax or national insurance should arise for the employee. Alternatively the income tax is limited to being by reference to the value at the original grant date rather than the date of exercise of the option.
Any gain from the value at date of grant to the date of an eventual share sale is generally subject to Capital Gains Tax (CGT) and most shares acquired through EMI schemes meet the conditions for the beneficial 10% rate of Capital Gains Tax by virtue of entrepreneurs’ relief.
2. A direct share award.
The employee will be subject to income tax on the market value of the shares at the point they acquire them. This route is often not as tax advantageous as an EMI option, however could be considered where businesses are less established therefore the market value of the shares is lower.
3. Issuing ‘Hurdle Shares’
This involves shares being allotted to employees which only start to return value on future capital growth. This way, the value of the shares at the date they are awarded to the employee could be £nil, such that no income tax should arise.
This option is often less lucrative for the employee but may be appropriate in scenarios where the original shareholders wish to retain the benefit of the capital value of the company to date.
4. Direct share award for market value but on a ‘nil paid’ basis.
Under this route, the employee would be issued shares at their market value, but the employee would only pay the nominal value of the shares at the date of issue. The balance would be left unpaid until they sold the shares, at which point they have the funds to pay the remainder.
This has the benefit of mitigating up front income tax without the employee having to physically pay any substantial consideration at the time of the acquisition. However, the amount would ultimately be due to the company and thought must be given to how this debt would get dealt with if, for example, the employee subsequently left the company.
5. A ‘Non-approved’ share option scheme, i.e. not through an EMI or other approved scheme.
The employee would be subject to income tax when they exercise the option on the difference between the market value at the date of exercise and the price they paid for them, making it far less tax advantageous than an EMI scheme mentioned above. However, the options could be structured such that they are only exercisable on an exit event, such that the tax only becomes payable when the employee has the funds available from a subsequent share sale.
There are other methods to delivering shares to employees, however these are the most common scenarios we have seen adopted in recent years by small and medium sized businesses.
How can we help?
Rickard Luckin have extensive experience in Employee Share Schemes. We can advise on the options available to your company in more detail, and recommend which route would be the most tax advantageous and would help your company achieve its commercial objectives.
We can undertake a valuation of your company to establish the tax liabilities that may arise under each of the scenarios above, and if an EMI scheme is appropriate, we can agree a valuation with HMRC.
We also have a statutory services team who can prepare the necessary statutory paperwork to implement the recommended scheme.
If you would like to find out more about potential routes for your company, please do get in touch.
You can contact Hayley Sheppard, Tax Manager, at [email protected]
or on 01245 254263.