Employee share schemes
By using an employee share scheme, you give employees a stake in your business and help improve its performance. It also encourages employee loyalty as to retain the shares; they have to continue to be an employee, so another benefit is the retention of valued staff. At the hiring end of employees, an employee share scheme can be used as an incentive or reward and can help recruitment. There are a number of share schemes, the two main schemes which are approved by HMRC are:
- Company Share Option Plan (CSOP);
- Enterprise Management Incentives (EMI) schemes.
This article is useful for employers and employees. It explains the various share award and share option schemes, including tax-advantaged and taxed schemes. It also describes the pros and cons of each and provides information on how to choose and manage a scheme that suits your business. All the documents and forms required to set up an Employee Share Scheme can be download using the link on the right.
Share options versus share award schemes
Share option schemes are typically used as an incentive for employees.
A share option is the right to buy a certain number of shares at a fixed price, some time in the future, within a company.
Employees can generally exercise their options - buy the shares - after a specified period, known as the vesting period. You can make the granting and exercising of options dependent on reaching certain targets, such as sales targets.
When an employee exercises their options, it's at the price fixed at the date of grant, that is, when the options were given to the employee, regardless of the prevailing market price. They can then keep the shares or, if the market price is higher, sell them at a profit.
Share award schemes involve giving employees actual shares rather than options, free or for less than their market value. The value of shares given to employees is treated as employment income - subject to tax and National Insurance contributions, unless you opt for an HM Revenue & Customs (HMRC) tax-advantaged (approved) plan which comes with restrictions and requirements. Share purchase schemes allow employees to:
- Buy shares;
- Save money to buy shares;
- Buy shares for a small deposit, paying the rest at a later date.
An employee share scheme can help a company's owners to transfer ownership to those working in the business, for example to family or to enable a management buy-out. You can sell your company gradually and obtain tax relief while doing this. The tax relief available depends on the share scheme you choose.
Employee share schemes can mean anything from:
- Giving free shares to employees;
- Granting them options to buy shares at a specified price after a specified period of time, or;
- Allowing employees to buy shares, and giving shares away if employees meet certain standards.
You should assess what is best for your business when choosing which kind of scheme suits you. You can:
- Make the award of shares or grant of options dependent on reaching certain milestones, for example, upon reaching a minimum number of sales;
- Structure the scheme so that employees become entitled to shares only if you sell or float the company;
- Limit the scheme to certain key employees, for example, those with scarce managerial or technical skills;
- Require a certain number of years' service - but beware of indirect discrimination. Females are likely to leave earlier than males so as to start a family;
- Run a combination of schemes or provide more favourable terms for directors. For example, you could run an Enterprise Management Incentive scheme for directors and a Share Incentive Plan for other staff. Make sure you consider the rules for tax-advantaged schemes before doing so.
Schemes approved by HM Revenue & Customs (HMRC)
Approved schemes have tax and National Insurance contribution advantages, whilst taxed (unapproved) schemes do not. However, taxed schemes don't have to meet the qualifying conditions for approved schemes, so they are more flexible.
While shares in publicly traded companies can be bought and sold easily, this isn't always the case in a private company, particularly if you have no plans to float or sell the business. If you want employees to realise the value of their shares, consider establishing and funding an employee benefit trust.
The trust can acquire shares for sale that aren't bought by anyone else and these can then be recycled - together perhaps with newly issued shares - to meet future demand from employees. There are two HMRC approved schemes:
- Company Share Option Plan (CSOP);
- Enterprise Management Incentives (EMI) schemes.
Company Share Option Plans and Enterprise Management Incentives
These schemes are typically targeted at selected employees or workers with unique or scarce skills.
Company Share Option Plan (CSOP)
Employers can grant employees options on up to £30,000 worth of shares each. The share price, fixed on the day the option is granted, must not be lower than the share's market value on that day. The employee can exercise their options after a specified period. If they do so, it is at the fixed price, not at the market price when they exercise the option
If they sell the shares at a profit, no income tax or National Insurance contributions (NICs) are due on the gains if certain conditions are met. Capital Gains Tax may be payable if gains exceed the employee's annual allowance.
Your business can get corporation tax relief for the costs of establishing and administering the CSOP and for the cost of providing shares under the scheme. Before granting options, you must obtain HM Revenue & Customs' (HMRC) approval.
Enterprise Management Incentives (EMI) schemes
For private companies the most popular type of share scheme is the Enterprise Management Incentive (or EMI) Scheme. First introduced in the Finance Act 2000 it allows qualifying companies to grant options over shares with a value of up to £120,000 per employee (up to a maximum of £3 million) on very flexible terms.
The gross assets of the company (or group) must not exceed £30 million and there must be less than 250 employees. Companies in property development, leasing and financial activities do not qualify to grant EMI options. Companies owned or controlled by another company do not qualify either.
Participants must be employees and must work at least 25 hours a week or at least 75% of their working time (which includes time spent in self-employed work).
Those holding 30% or more of the share capital do not qualify to be granted EMI options.
To get started, all you need is the required document setting out the rules, or Scheme Rules and a pro forma EMI Option Agreement. These can be very simple ad hoc documents, however, as with all legal documentation, we recommend you use standard template versions so as to ensure you comply with the law. The advantage of Scheme Rules is that the incentive will be an employees’ share scheme under the Companies Act 1985 and Companies Act 2006. This means that a. a resolution to give the Directors authority to allot shares and b. to misapply statutory pre-emption provisions on new share issues, do not need to be put in place.
The advantage of an EMI option is that the employee only pays tax when he sells the shares not when he acquires them. The tax is Capital Gains Tax at 18% or 10% if the employee has held the shares for one year and qualifies for Entrepreneur’s Relief (which means he must hold 5% of the share capital).
The CGT annual allowance (£9,600 at July 2008) is available. For non EMI options which are not granted under other HMRC-approved share schemes option holders pay Income Tax at rates of up to 40% on exercise of the option. There can also be employer’s NIC at 12.8% on the option gain if the option is exercised at the time of a company sale or if the shares become tradable on a public market such as AIM.
It is possible to operate an EMI scheme using new issue shares or existing issued shares which can be warehoused in an Employee Benefit Trust.
Options must be exercised within ten years.
Please note that the information provided on this page:
- Does not provide a complete or authoritative statement of the law;
- Does not constitute legal advice by Net Lawman;
- Does not create a contractual relationship;
- Does not form part of any other advice, whether paid or free.
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EMI Share Scheme agreementPrice £39.00 Format Available: Read More
Employee share scheme (EMI): board minutes and noticesPrice £5.00 Format Available: Read More
Documents to start an Enterprise Management Incentive schemePrice £49.00 Format Available: Read More
Enterprise Management Incentive (EMI) share option agreement pack: conditional on exitPrice £49.00 Format Available: Read More
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