This employment law briefing explains the benefits of employee share schemes and identifies the different types of scheme that are available.
What are the key business benefits of employee share schemes?
The main benefits are financial and motivational:
- Tax and NICs savings. Some types of share scheme attract particular income tax and national insurance contributions (NICs) advantages that can help reduce a business’s employment costs. Corporation tax relief may also be available.
- Employee retention. They can help the recruitment, retention and motivation of high-calibre staff, and the alignment of shareholder and employee interests.
- Conserving cash. There may be less pressure on salaries if a business offers a share plan.
- Employee performance incentive. They can act as an incentive for employees to meet key business and financial targets.
- Succession planning. Ownership of a business can be gradually transferred to its employees, rather than to new outside shareholders, through awards made under employee share and share option plans.
What are the different types of schemes that are available to businesses?
Some employee share schemes benefit from favourable tax and NICs treatment. There is also a range of other share incentive schemes without statutory tax advantages (called non tax-advantaged or unapproved schemes), which businesses may find useful due to their flexibility. Some non tax-advantaged arrangements enjoy certain tax benefits arising from the way they are structured, rather than any special reliefs, but these tend to be more complicated to implement.
Enterprise management incentives (EMI) share options
EMI share options are specifically targeted at smaller, higher-risk trading companies. Certain trades do not qualify, as they are seen as insufficiently risky. EMI options do not have to be offered to all employees and attract very favourable tax treatment, which will be particularly appealing to higher rate and additional rate taxpayers. There are limits on the value of options granted to each employee and the total value of shares that can be placed under option. The EMI legislation is the most flexible and generous of the UK’s four tax-advantaged share plan regimes.
Company share option plans (CSOPs)
CSOPs give employees the right to buy shares at a specified time in the future (usually at least three years after grant) at a price which is set at the outset. The employee makes no initial financial commitment or future obligation to exercise the option. CSOP options do not have to be offered to all employees. Companies which do not qualify for EMI options because they are too big, or do not meet the requirements regarding their trading activities, may be able to use CSOP options. As for EMI options, there are limits on the value of options granted to each employee, but these are less generous than for EMI options. Again, the tax advantages make CSOP options particularly appealing to higher rate and additional rate tax payers.
Save as you earn (SAYE), sharesave, or savings-related share option schemes
In an SAYE option scheme, the employee agrees to save a certain amount each month for a specified period, with an approved savings provider. The employee can then choose whether to use the proceeds of their savings to buy shares. If the employee does not want to buy the shares, they can choose to have their savings and a tax-free bonus paid out in cash instead. Participation in an SAYE option scheme has to be offered to all qualifying employees. SAYE option schemes tend to be used more by larger (often listed) companies, as their administration can be quite demanding.
Share incentive plans (SIPs)
SIPs enable employees to acquire shares (as opposed to share options) in their employing company (or their employer’s parent company). The company can offer partnership shares, which employees buy out of their pre-tax income and/or free shares. The company can also offer additional free shares, called matching shares, to those who buy partnership shares. The company can choose whether to offer reinvestment of any dividends on SIP shares in further shares, known as dividend shares, or to pay the dividend straight to the employee. Participation in a SIP has to be offered to all qualifying employees. SIPs tend to be used more by larger (often listed) companies. They require an onshore statutory employee benefit trust to hold the participants’ shares, and the fact that participants are shareholders from day one means their administration can be quite demanding.
Non tax-advantaged schemes
The most common arrangements are:
- Non tax-advantaged share option schemes. These are similar to EMI options and CSOP options (but obviously without the tax advantages), but there is greater flexibility in the terms that can apply to the options and shares.
- Nil paid or partly paid share schemes. These involve the acquisition of shares on the basis that all or part of the purchase price is left outstanding until a later date. They offer certain tax advantages, but require careful structuring.
- Growth shares. These are a special class of employee share designed to have a low value on acquisition, but entitling the shareholder to a share in any growth in value of the company. Again, they offer certain tax advantages, but require careful structuring.
- Jointly-owned equity arrangements. These involve the acquisition of shares jointly by the employee and a co-owner, which is usually the trustee of an employee benefit trust. Broadly speaking, the trustee is entitled to the current value of the shares plus an annual charge, and the employee is entitled to any growth in value, less the cumulative trustee’s charge. Again, they offer certain tax advantages, but require careful structuring.
- Long-term incentive or performance share plans (LTIP/PSPs). Executives are awarded shares (generally at nil cost) subject to a period of continued employment and meeting a performance target.
- Share matching plans. The executive agrees to buy and hold shares (possibly out of a bonus) and the company matches this with an award of free shares if performance and service conditions are met.
What about using share plans for employee ownership?
Employee share plans can be used to promote employee ownership, either on their own or in conjuction with a more formal employee ownership structure. The company can put in place a statutory employee-ownership trust (EOT) to hold a majority of the company’s shares on behalf of employees. There is a capital gains tax relief for a transfer of a majority holding to an EOT, and an income tax relief for bonuses paid by a company owned by an EOT. For the reliefs to apply, certain statutory conditions must be met. In addition, a company owned by an EOT may be able operate tax-advantaged share schemes.
How does the employee shareholder employment status fit in with employee share plans?
Although employee shareholder employment status is not an employee share plan, the shares acquired by the employee shareholder can be acquired under an employee share plan. Alternatively, the shares could be issued directly by the company outside a share plan. For the status to apply, a number of statutory conditions must met. Certain employment rights must be given up in exchange for shares. A limited income tax and NICs relief applies to the acquisition of the shares, and a more generous CGT relief applies when the shares are disposed of.
What factors should a company consider before adopting a share scheme?
- What is the plan intended to achieve? The particular type and design of share scheme will be influenced by the purpose the company intends to achieve. If the plan is intended to tie in key employees, then the arrangements may be structured differently to a plan intended to motivate employees to work towards and exit, or a plan intended to share the success of the company with a wide group of employees. Identifying this purpose early on will help guide the company towards the correct structure.
- Selling a private company. Share plans need to be carefully structured to accommodate possible future sales of the company. As it is common for share options to be exercised in connection with a sale, suitable replacement arrangements may need to be put in place to help retain key employees after the sale.
- Listing a private company. Existing share incentive plans are likely to have to be restructured when a company is floated. Arrangements to incentivise employees to work towards the float may become exercisable, and may need to be replaced. Once listed, a company will need to consider the statutory reporting obligations and the non statutory guidelines and rule books that affect the design, adoption and implementation of share plans.
- Leavers’ rights. Initial considerations about the design of a share plan should take into account what should happen to leavers under the plan, and how these provisions will interact with any leaver provisions in the company’s articles of association.