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Jeremy Over | 27.04.2020
07.03.2018 Thomas Clark
A modern employee incentive means more than just salary
Salaries can be similar from employer to employer. An added Employee Share Incentive Scheme, however, can help recruit, retain and motivate employees.
Crucially, they can also be used to help align the interests of employees, particularly senior executives, with those of shareholders and encourage senior executives to consider the best interests of shareholders in their management of the business. This can ultimately maximise value on the lead up to an exit.
Employee Share Incentive Schemes can also help to reduce employment costs by moving part of the employees’ incentive from the Pay As You Earn and National Insurance regime to the Capital Gains regime.
What schemes and arrangements are available?
Employee share schemes take many forms, but schemes can be divided into tax-advantaged share schemes and non tax-advantaged. For the purpose of this article we focus on the two most popular schemes, Enterprise Management Incentives (EMI Options) and Growth Shares.
EMI Options are essentially options granted to an employee to acquire shares in a company, usually at the point of exit, although sometimes it can be prior to that. EMI Options enjoy favourable tax treatment and are specifically targeted at small, higher-risk, developing trading companies.
A number of statutory requirements must be met in order for a company to qualify to grant EMI options. In particular, a company must be an independent trading company with:
Gross assets of no more than £30 million; and
Fewer than the equivalent of 250 full-time employees.
Certain trading activities will not qualify and there are detailed rules relating to the independence requirement, the trading requirement and the shares that can be used.
EMI Options can also be conditional on time served, or performance, or subject to a ratchet that provides that the higher the value, the higher the reward.
Where all the requirements are met, the exercise of the EMI Option benefits from favourable tax treatment which could be as low as 10% of qualifying gains if shares acquired on the exercise of EMI Options qualify for Entrepreneurs’ Relief.
Importantly, it can be a condition of the exercise of the EMI Options that if the employee departs prior to exercise, the EMI Option lapses and so there is no need to put arrangements in place to ensure that shares are transferred back; or to consider the rights of the employee as a shareholder prior to exercise of the EMI Option.
Under a Growth Share scheme, an employee acquires an interest in shares upfront but the structure of the scheme is such that these shares only benefit from the increase in value in the business. That way, the existing value is reserved for the existing owners.
This structure also allows taxation at the point of issue to be low because the growth shares at that time of issue have little or no value. But at the point of exit, the shares are taxed on a Capital Gains Tax basis, which again could be as low as 10%.
Are schemes complex and burdensome?
Employee share schemes can be as simple or complex as required but as a minimum it is important to ensure that the structure is right for the particular business, that a share scheme protects the interests of the existing shareholders, and that it achieves the tax treatment intended. Too often schemes are structured badly, meaning that more
tax is payable than is needed.
Often, we can put schemes in place quickly in a simple manner, and once a scheme is in place, adding further employees can be very simple and cost effective.
Cash bonus seems simpler?
Take an example of an employer trying to give an employee an incentive of £100,000 after tax: The employer pays a bonus and may need to gross up the amount by almost £90,000 to ensure that the employee receives £100,000. Whilst the employer may set some of those costs against its own Corporation Tax, it may also have to pay employer’s National Insurance of over £25,000.
Contrast that to EMI Options where the employer may only need to gross up the amount by a maximum of around £22,000 to take into account Capital Gains Tax at up to 20% (less if at 10%). In addition, the employer may benefit from some Corporation Tax relief and would not pay employer’s National Insurance.
Moore Blatch does not provide tax advice but works closely with an employer’s existing (or new) tax adviser to ensure that the scheme achieves the best tax treatment. The exact tax treatment will depend on specific circumstances.