Employee share schemes

Article reference: UK-IA-EMP18
Last updated: September 2022 | 5 min read

Starting an employee share scheme is a way of giving employees a stake in your business. Commonly, schemes are set up to improve employee motivation and loyalty, to retain current, valued staff, and to provide an incentive for new employees to join.

A scheme can also help company owners (including founders) to transfer ownership to those working in the business; for example, down generations of family members or with the aim of eventually allowing a management buy-out. Using a scheme, owners can sell the company gradually and obtain tax relief while doing this. The relief available depends on the share scheme chosen.

Different types of share schemes

There are three main types of scheme.

Share award schemes involve giving employees shares. The value is treated as employment income and subject to income tax and National Insurance contributions unless the plan is 'approved' by HMR&C as 'tax-advantaged'. Tax-advantaged schemes are subject to restrictions and requirements.

Share option schemes give an employee the right to buy a certain number of shares in the company at a fixed price, at some time in the future.

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 achieving certain goals, such as reaching a sales target or developing a working prototype.

When an employee exercises his or her options, he or she does so 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. He or she can then keep the shares or, if the company is listed on a stock exchange and the market price is higher than the option price, sell them at a profit.

Share purchase schemes allow employees to: buy shares; save money to buy shares; or buy shares for a small deposit, paying the rest at a later date.

Schemes approved by HM Revenue & Customs

Approved schemes have tax and National Insurance contribution advantages, whilst unapproved schemes do not. However, unapproved schemes do not have to meet the qualifying conditions that approved schemes do, so they are more flexible.

The two main schemes that are approved by HMR&C are:

  • Company Share Option Plan (CSOP)
  • Enterprise Management Incentives (EMI) scheme

These schemes are typically targeted at selected employees or workers with unique or scarce skills.

Company Share Option Plan

Employers can grant employees options on up to £30,000 worth of shares each. The share price, fixed on the day that the option is granted, must not be lower than the share's market value on that day. The employee can exercise his or her options after a specified period. If he or she does so, it is at the fixed price, not at the market price.

If the employee sells the shares at a profit, no income tax or National Insurance contributions (NICs) is due on the gains if certain conditions are met. Capital gains tax may be payable if gains exceed the employee's annual allowance.

A business can receive 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 approval from HMR&C.

Enterprise Management Incentives (EMI) schemes

For private companies the most popular type of share scheme is the Enterprise Management Incentive (or EMI) Scheme. 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.

Qualifying terms include:

  • The gross assets of the company (or group) must not exceed £30 million and there must be fewer 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.
  • 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.

We discuss the requirements for qualifying under an EMI share scheme in more detail.

An EMI scheme is classed as an employees’ share scheme under the Companies Act 1985 and Companies Act 2006. Accordingly, shareholders do not need to pass a resolution to allow directors to allot shares to the scheme, or to misapply statutory pre-emption provisions on new share issues.

An employee only pays tax when he or she sells the shares not when he or she acquires them. Capital gains tax is charged on amounts over the CGT allowance, although this can be reduced by other reliefs such as Entrepreneur’s Relief (if the employee qualifies). Income tax is rarely chargeable (read more about income tax on Enterprise Management Incentives share schemes).

In comparison, other employees of other share schemes which are not approved pay income tax when the option is exercised. This can be far higher (sometimes more than double) CGT.

Employer’s National Insurance contributions on the gain may also be payable by the employee 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.

Net Lawman sells a number of share option agreement templates, including option agreements for employees.

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