He Who Shares Wins (Part 2)
Simple and Effective Share Schemes for Private Companies
Once you have decided that you would like to implement an employee share scheme there are, broadly speaking, three different types of scheme to consider:
1) a share purchase scheme;
2) a share option scheme either approved by HMRC or with tax advantages from following prescribed rules; or
3) an unapproved share option scheme.
For HMRC approved shares and EMI options, HMRC will agree the value of the option shares ahead of the award. Sometimes it is not possible to meet the criteria of the HMRC approved or tax advantaged schemes. In these circumstances, an unapproved share option scheme may be the only alternative.
Share Purchase Scheme
Employees are awarded shares in the company immediately at an agreed valuation. The shares are often granted with restrictions relating to matters such as dividends, transfers of shares, voting rights and with compulsory buy-back provisions applying to the shares of any employees who leave the company. These restrictions can be put in place at the time of issue of the shares, but could fall away after a period of time.
Tax Advantaged Schemes
A share scheme approved by HMRC or following tax guidelines has various advantages. Approved schemes include SAYE (Save As You Earn), CSOP (Company Share Option Plan) and the SIP (Share Incentive Plan). Alternatively, the EMI (Enterprise Management Incentive) Scheme is recognised by HMRC but does not require approval. All of the schemes are outlined below.
This scheme allows tax-advantaged options to be granted to employees. By tax-advantaged, we mean that the growth in value of the EMI options will be subject to capital gains tax when shares are sold rather than income tax when the option is exercised.
The maximum value (at grant) of shares to be put under EMI options is £250,000 with the maximum duration of an option being 10 years. EMI options however cannot be awarded by a company under the control of another company.
To avoid complications with payments of dividends, owner-managers can choose to award EMI options that can only be exercised when and if there is an exit. The advantage of such options is that the founders do not need to concern themselves with designing a constitution that reflects wider share ownership. The disadvantage however is that, as the life of an EMI option is limited to 10 years, a well advised employee may take the view that the EMI option may (rightly) be perceived as an award that has value at the discretion of the founders, i.e. if they decide to sell.
SAYE (Save As Your Earn)
This is an all employee share option scheme, in which the employees can save from £5 to £250 per month out of taxed income on a 3 or 5 year saving contract. Employees are offered the option to buy shares in the company at a future date, with, say, a discount of up to 20% of the current price. Bonuses are then paid, equivalent to fixed rate interest and are set by the Treasury.
At the end of the agreed period, contributors to a SAYE scheme can either use the money saved, with the bonus and interest, to buy shares in the company, or can have their contributions returned to them. The bonus and any gains made on the shares are exempt from income tax and NICs. Capital gains tax however may be payable if the amount exceeds the annual personal allowance.
Due to the “all employee” nature of these schemes, they are typically only implemented by larger companies who wish to tie in employees for a period of time.
This is another, albeit complex, all employee share scheme, under which employees are gifted shares or purchase them. There are three potential components; Free Shares, Partnership Shares and Matching Shares.
The Free Shares Module is a share gifting scheme under which a maximum value of £3,600 of shares can be awarded in each tax year. The holding period of these shares in a trust cannot be less than three years to more than five.
Under the Partnership Module, an employee can allocate up to £1,800 or 10% of pre-tax salary (whichever is lower) to be used to buy additional shares. There is no holding period as with the Free Shares.
Matching Shares are matched to an agreed ratio which cannot exceed 2:1 to those already purchased under the Partnership Module. This cannot apply to Free Shares.
CSOP (Company Share Option Plan)
The CSOP is a discretionary share option scheme, historically used for selected directors, but increasingly used as an all-employee scheme. Share options are granted up to an initial market value of not more than £30,000 (at no less than market value).
The purchase can be made using the employees’ own funds, or through a loan arrangement. The employee can sell back as many shares as it takes to repay the loan, creating a “cashless exercise”. The options can be exercised free of income tax between the third and tenth anniversaries of the date of grant.
Unapproved Share Option Scheme
Sometimes it will not be possible to meet the criteria of any of the above HMRC approved or tax-advantaged schemes. In these circumstances, an unapproved scheme may be the only alternative. An obvious advantage with such a scheme is that they can be very flexible, however there may be a high tax charge triggered on exercise, even if the shares have not been sold. They may not, therefore, be an effective incentive.
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A successful design of a share scheme involves a complex interplay of commercial, tax, valuation and legal issues.
If you would like further information on employee share schemes please visit our dedicated Employee Share Scheme page or contact us to talk through your options by phone on 0845 686 0962 or by email: james.hunt@everymanlegal.com.
