Since their invention more than 50 years ago, employee share ownership schemes have proved a popular way for companies to retain and motivate staff. Several different schemes exist and accountants should be aware of the pros and cons of each in order to advise clients on them.
Time limit for notifying HMRC after granting employee options
A key consideration is whether a scheme is approved by HMRC or not. HMRC-approved schemes have considerable tax advantages but they also have restrictions that make them unsuitable for certain companies. When advising clients on these schemes, it is necessary to balance the needs of the business with the tax considerations. There is no point opting for a tax-efficient scheme if its restrictions defeat the company’s strategic objectives.
"Companies need to make important upfront decisions about the scheme before implementation planning has started," says Michael Murphy, tax partner at law firm Lawrence Graham. "Do they want a scheme for all employees or just a discretionary scheme for senior management? Do they want to give options or shares? Do they specifically want an HMRC-approved scheme?"
Almost all schemes, approved by HMRC or not, are eligible for corporation tax relief – one reason why companies view them as an attractive incentive. So the main driver from a tax-planning perspective is minimising the tax charge paid by the employee granted the award. With approved schemes, all growth in value should be taxed within the capital gains regime rather than as employment income. That means any gains are normally taxed at a capital gains tax rate of 28% instead of an income tax rate of 40%-50% in the current tax year. Employees will also benefit from the £10,600 CGT tax-free allowance.
Of the various options, the HMRC-approved enterprise management incentive (EMI) scheme is generally considered the most attractive. Launched in 2000, it is aimed at SMEs. To qualify they must be based in the UK, have fewer than 250 full-time staff, be an independent trading company or group with less than £30m in gross assets, and not belong to excluded business sectors such as financial services. Up to £250,000 in share options can be granted to selected employees with a limit of £3m for the total value of options granted at a time.
Eligible employees must work for a minimum of 25 hours per week or be employed for at least 75% of their full working time.
No HMRC approval needed
A big advantage of EMI is that companies don’t need HMRC approval for the scheme to qualify for EMI tax relief. But they must notify HMRC within 92 days of granting the options. Staff pay no income tax or NICs when the options are granted or when they are exercised, provided the option price is at least the market value of the shares when the options were granted. Employees just pay CGT on gains they make after exercising the options and selling the shares.
In the Budget the government outlined proposals to extend entrepreneurs’ relief (ER) to shares acquired through EMI options exercised after 6 April 2012. This means employees would be able to sell their shares and pay a CGT rate of just 10% on their disposal gains. "On paper, employees should be able to get a 10% ER CGT rate," says Peter Rayney, an independent tax consultant specialising in owner-managed businesses. But he points out that the normal ER one-year share ownership period still applies to EMI-option shares. This will be problematic for most EMI schemes where the intention is that employees exercise their options and sell their shares just before the company is sold.
Besides EMI, the three other HMRC-approved schemes are company share option plans (CSOPs), share incentive plans (SIPs) and save as you earn (SAYE) plans. All require prior approval from HMRC, which usually takes three to four weeks. "When companies have more than 250 employees they generally look to a CSOP," says Rayney. "But you can’t give away much – they are quite restrictive."
Under a CSOP, a company is limited to granting each employee an option on up to £30,000 worth of shares, which they can exercise after a set period of at least three years. If they then sell the shares and make a profit that exceeds their annual allowance, they will have to pay CGT. But no income tax or NICs are due.
Under a SIP, employers can give staff up to £3,000 worth of free shares held in a trust, while the SAYE allows employees to save £5-£250 per month over a three-, five- or seven-year period with the employer granting them options. With both schemes, gains are treated as capital rather than income profits, provided certain criteria are met, and every eligible employee must be given the chance to participate.
approved or not?
There are several unapproved schemes that may better suit a company’s needs. The tax treatment usually depends on whether the shares are readily convertible assets (RCA). If they are, the relevant gains are generally subject to income tax and NICs deducted through PAYE. If not, the relevant income tax is payable via self-assessment. Corporation tax relief is available for the cost of providing the shares subject to certain restrictions.
Unapproved schemes include the following:
- taxed share option plans – similar to EMI and CSOP but with no limit on the amount or value of options;
- phantom share option plans – a cash bonus is awarded according to the increase in value of a specified number of shares covered by an option;
- long-term incentive plans – involving shares or securities that are held for a year or more;
- taxed employee share schemes;
- convertible shares and securities – rewards convert into different shares and securities at a later date; and
- employee benefit trusts.
Murphy believes growth share schemes are also becoming popular among companies. These are schemes where employees are given a special class of share in a company that has no immediate value but is able to participate in the company’s growth.
Options abound when it comes to employee share ownership schemes and figuring out the best for your client may not be easy – or whether it’s worth your client embarking on a scheme at all.
Although a simple, unapproved discretionary scheme for a small group of employees can cost as little as £3,000, an approved scheme for the whole workforce with monthly contributions and regular statements can cost £50,000 to implement and £30,000 to run each year, says Murphy.
"As an employee you may prefer to have cash in your bank account now rather than shares or options whose future value is not guaranteed," says Frank Haskew, head of ICAEW’s Tax Faculty. "Poor stock market performance in recent years means that many people are sitting on options that are worth less than when they were granted." However, adds Haskew, "If shares are low at the moment it might be worth doing something now in the hope that things will improve."
Top tips for advising on employee share ownership schemes
The process can take up to 15 months so you need to keep the client engaged.
Be methodical – make a checklist that covers all relevant considerations.
When entering an HMRC-approved scheme ensure the scheme rules comply and are followed.
Provide a robust share valuation to HMRC, especially where there is no ready market for them.
Make sure you follow all the relevant company law requirements.
In most cases, make sure the employer and employees make a section 431 election under the Income Tax (Earnings and Pensions) Act 2003 within 14 days of the options being awarded. This will avoid any part of any future profit on sale being taxed as employment income.
Remind the client that they need to file an annual return (Form 42) reporting all employee share transactions by 7 July each year.
Make sure employees understand how their particular scheme operates.
Don’t forget about the corporation tax deductions when doing the company accounts.
Consider the reporting implications. When a company grants share options to its employees it has to expense a fair value charge to its profit and loss account. This charge is spread over the vesting period of the option, typically three years. But companies that apply the Financial Reporting Standard for Smaller Entities are normally exempt from this requirement.