Employee Share Plans – What are the Options?

Posted on 03 July 2018

Employee Share Plans – What are the Options?

Faced with the prospect of Enterprise Management Incentive ("EMI") plans not being approved by the European Commission, for a period of around one month, many of our clients were concerned with how they would be able to incentivise their key people through tax efficient equity plans.

A quick reminder

EMI plans are the most popular type of employee share plans offered in the UK by small and medium sized companies. EMI's provide significant tax benefits over other types of share plans and have the added benefit of being highly flexible in the way in which it can be structured and operated.

The key tax breaks are that (provided the statutory requirements are met) the entire option gain is subject to the more favourable capital gains tax regime, rather than income tax. In addition, provided the combined period over which the option and relevant shares are held is at least 12 months, an employee who sells their EMI shares pays tax at the lowest capital gains tax rate of 10%.

Currently, EMI plans are subject to EU State Aid rules, which means that every 5 years the UK must apply to the EU for an extension of the applicable tax benefits. However, this year, with prior approval due to expire on 6 April 2018, the EU failed to give its consent in time, meaning that EMI plans were generally put on hold until consent was given.

Whilst such consent came through in mid-May, it became clear that companies needed to explore alternatives to EMI plans and consider what other arrangements could be implemented that also provide tax benefits.

What alternatives are there?

EMI plans will not be suitable for all companies, generally because either the company is too big (it needs to have gross assets of no more than £30 million), it operates a trade that does not qualify under the rules or the company or individual limits may have been reached.  In these circumstances, the following plans should be considered:

  • Company Share Option Plan: this is another type of HMRC sponsored share option plan. The individual limits are lower (options over only £30,000 worth of shares can be granted to any one individual), but these types of options still fall within the capital gains tax regime if operated in accordance with the regulations.
  • Growth Shares: this involves setting up a new special class of share that employees subscribe for. The shares are subject to various restrictions (for example they are non-voting and non-dividend bearing) and will have a financial hurdle attached to them before they accrue any vesting. As this is not an HMRC sponsored plan it is highly flexible and provided the employees subscribes for the shares at their initial market value (which should be very low), the entire growth in value is subject to capital gains tax rather than income tax.
  • Joint Share Ownership Plans: again there is lots of flexibility in how these plans operate. The ownership of the shares are split between a third party (typically an employee trust) and the employee. The third party is entitled to retain all current market value (plus a coupon) and the employee has the benefit of any future growth. As such, a JSOP award effectively mirrors a market value share option in that the award will only be valuable to the employee if the value of the company increases.
  • Save As You Earn: whilst typically operated by larger companies, SAYE gives employees the opportunity to save an amount of money each month over the option period (either 3 or 5 years). At the end of the savings period the employee can use their savings to buy shares at a price equal to the market value of the shares at the start of the savings period, plus up to a 20% discount. The option gains is subject to capital gains tax, not income tax.
  • Share Incentive Plan: under a SIP, employees can buy shares in the company out of pre-tax salary. Limits apply, but provided that the shares are held for five years, on sale, they can be sold completely tax free. The company can also award free shares and any dividends earned can also be paid out in additional shares.
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